RBI MPC Review: Increasing pivot room as slowdowns loom

9 Feb 2023 , 10:45 AM

The RBI raised policy rate by 25 basis points to 6.5%, in line with expectations. However, contrary to expectations, it did not provide any explicit forward guidance on policy direction, and yields rose. RBI introduced growth and inflation estimates for FY24 at 6.4% and 5.3% respectively. Analysts at IIFL Capital Services feel that FY24 estimates may see downgrades, when lag effects of policy rate hikes around the world, take effect. They continue to expect that RBI will pause in its next meeting, given the unexpectedly rapid fall in sequential inflation. Further, it is worthwhile to note the growing dissent amongst MPC members, with two external members already calling for a pause as well as change in stance. Expect pivot soon.

Policy announcements in line with expectations

RBI MPC hiked policy rates by 25 basis points (4:2 majority) to 6.5% — in line with IIFL/consensus expectations. Accordingly, SDF stands adjusted to 6.25% and MSF rate to 6.75%. There was no change in CRR rate. The central bank maintained its current stance of withdrawal of accommodation (4:2 majority) — a section of market was expecting a change to neutral. Stance was maintained, given that adjusted for 1 year forward expected inflation (5.6%), the policy rate still trails its pre-pandemic levels with liquidity still in surplus.

Optimistic on growth while pessimistic on inflation

RBI introduced real GDP growth for FY24 at 6.4%, in line with base case laid by the Economic Survey. Quarterly breakup: 7.8% (Q1FY24), 6.2% (Q2FY24), 6% (Q3FY24) and 5.8% (Q4FY24). Analysts at IIFL Capital Services see risk to FY24 growth numbers, as global slowdown led by monetary tightening impacts external demand, delays investment pickup and pent-up effects post COVID normalize. FY23 GDP growth at 7%, as per NSO’s estimate, exceeds RBI’s estimate of 6.8% in the last meeting and looks a bit stretched.

Average inflation for FY24 at 5.3% seems pessimistic on the other hand, with sequential momentum slowing down considerably. Quarterly breakup: 5.0% (Q1FY24), 5.4% (Q2FY24), 5.4% (Q3FY24), 5.6% (Q4FY24). FY23 average inflation has been revised downwards marginally to 6.5% from 6.7% earlier, due to favorable inflation prints in the past couple of months.

Inflation moderating on sequential basis; oil prices under control

We are witnessing rapid fall in sequential, seasonally adjusted inflation – US headline and core inflation below 3% on 3mma SAAR basis. For India also, headline inflation is at 3% while WPI inflation is negative; similar trends expected in EU. For US, replacing the lagging indicator Shelter with an average of home price and rental real-time indices, yields a startling near-zero figure. Further, RBI has assumed oil at $95/bbl., but Brent has been unable to breach the $90/bbl mark, despite the EU ban and China re-opening. CRB food index is down 12% from peak and a good Rabi harvest provides further cushion.

Explicit forward guidance missing, but an early pause still on cards

RBI did not provide any forward guidance on policy direction, which left the market puzzled and hence, yields spiked by 5-10 basis points across the curve. However, given the current inflation momentum, analysts at IIFL Capital Services feel it is likely that a couple of benign inflation prints, some easing in core inflation, and a pause by RBI — could follow in the next meeting. Further, it is worthwhile to note the growing dissent amongst MPC members, with two external members already calling for a pause as well as change in stance.

Expect steady long-term yields, INR

Long-term rates should find support from fiscal consolidation as well as a minor rise (6.5% YoY) in market borrowings announced in the FY24 budget. Further, as inflation continues to recede globally and risk-on sentiment improves, FII flows to EMs and India should stabilize. With RBI’s active intervention, analysts at IIFL Capital Services see INR to stay stable within 81-84/USD. Possible India inclusion in GBIs in 2024, could be the icing on the cake.