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India Economics: A job not finished

 22 Feb 2024

Key takeaways

  • As expected, the RBI kept the repo rate unchanged at 6.5%, and held on to its “withdrawal of accommodation” stance
  • It aligned its ‘hawkish’ stance with still-incomplete transmission and inflation ruling above its 4% target; it raised its FY25 growth forecast to 7%; it discussed risks around “recurrent shocks”
  • We believe the RBI is in no hurry to ease; we expect limited rate cuts of 50bp from mid-2024, taking the repo rate to 6%

The RBI kept the policy repo rate unchanged at 6.5%, in line with expectations, in its monetary review meeting on 8 February. Five of six members voted for a pause in rates, versus all six voting for a pause last time. Prof Varma voted for a 25bp repo rate cut. 

As before, five of the six members voted for a continuation of the “withdrawal of accommodation” stance. Prof Varma voted for a change in stance to neutral.

Holding tight

The main takeaway for us was that the RBI is in no rush to ease monetary conditions. 

One, in the press conference Deputy Governor Patra spoke about the intent always having been to keep the call money rate aligned to repo rate at 6.5%. But several exogenous reasons, primarily elevated government balances with the RBI, had led to the call money rate hovering at a higher 6.75%. Now, with both central and state governments spending into year end, this exogenous issue could get ironed out, keeping the call money rate more sustainably at 6.5%. This fall from 6.75% to 6.5% should not be construed as RBI’s indication of monetary policy easing. 

Two, the RBI explained that its stance of “withdrawal of accommodation should be seen in the context of incomplete transmission of repo rate hikes, and inflation ruling above the 4% target. On the former, the RBI was most concerned about incomplete transmission in credit market (see chart 1). On the 4% inflation target, it reiterated its intention to get inflation back to 4% in a “timely and sustainable manner”, saying that the “last mile” tends to be the toughest.

Three, the governor spoke about “markets front running central banks” in many parts of the world. And in a related context he mentioned “recurrent shocks” that threaten to un-anchor inflation expectations. He spoke about ongoing disruption in the Red Sea as an example.

Four, the RBI raised its FY25 growth target from 6.5% to 7.0%. This is higher than consensus expectations of about 6.3%. If RBI believes growth to be this strong, the need for monetary easing may not be urgent. Rather, its utility may be more to align real rates (for instance, neutral real rate of c1.25% alongside one-year-ahead inflation expectation of 4.75% gives a repo rate of 6%, which is 0.5ppt lower than where its trending now). And that can wait for a bit longer.

Alongside, it maintained the FY25 inflation forecast at 4.5%, with 2H being a shade higher than 1H (4.7% vs. 4.5%). 

Finally, there may have been some expectations of CRR cuts and other ways to infuse liquidity in the market. But here the RBI made it clear that durable liquidity remains in surplus.

All said, there is no rush to ease via liquidity, stance, or rates, though going ahead the call money rate may align better with 6.5% than in the past few months. 

Our sense is that the RBI will wait for cues from the Fed before deciding its next step. We expect a light easing cycle of two 25bp repo rate cuts from June onwards (in line with our Fed call of a first rate cut in June), taking the repo rate from 6.5% now to 6.0% by year-end.

Source: RBI, Bloomberg, CEIC, HSBC. WALR stands for Weighted Average Lending Rate. WADTDR stands for Weighted Average Domestic Term Deposit Rates. Note: Policy rate, money market rate and bond yields are as of 7 Feb 2024 close. Lending and deposit rates are as of Dec 2023

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