Monetary Policy Review: August 2023

The Monetary Policy Committee (MPC) today voted unanimously to keep the policy repo rate unchanged at 6.50% and also retained its “withdrawal of accommodation stance” with a majority of 5-1. Accordingly, SDF, MSF and CRR rates were also maintained at 6.25%, 6.75% and 4.5% respectively. However, in a surprise move, it introduced requirement of 10% Incremental CRR to be maintained by banks on rise in Net Demand and Term Liabilities of banking system between 19th May 2023 to 28th July 2023. This decision will be reviewed on or before 8th September 2023.

On Growth: RBI noted that global growth is showing signs of slowdown amidst tighter monetary policy and elevated, albeit moderating, inflation. Further, emerging economies also remain susceptible to weakness in global trade and tighter financial conditions. However, the better than anticipated growth has increased confidence in narrative of “soft landing”. For India, economic activity is holding up well and most indicators point at steady growth momentum. The consumption demand, especially Urban, remains healthy reflected in rise in Services PMI, PV sales, air traffic, etc. Rural demand is also gradually recovering. Investment activities also remain buoyant with robust cement and steel production along with growth in capital goods imports.

GDP Growth (%)	Jun-23E	Aug-23E
Q1FY24	8.0	8.0
Q2FY24	6.5	6.5
Q3FY24	6.0	6.0
Q4FY24	5.7	5.7
FY24 full year	6.5	6.5
Q1FY25	NA	6.6

Source: RBI

RBI kept its growth estimates unchanged for FY24 on back of good progress in crop sowing, perky services activity and consumer optimism. Further, investment spending is expected to remain supported by government spending and conducive private capex environment. However, the drag of global growth through trade channel is likely to impact exports and weigh on growth.

On Inflation: CPI accelerated in June on back of broad-based pick up in food inflation led by vegetables and cereals. However, comfort is derived from the fact that the core inflation continues to moderate and is significantly off its peak. RBI noted that CPI is likely to surge in near term on back of sharp spike in vegetable prices but expect it to correct substantially in coming months in line with past trends. However, RBI highlighted that monetary policy can look through high inflation prints caused by such shocks for some time. Apart from food prices, rise in crude prices also poses an upside risk to CPI estimates. Further, buoyant industrial and services activity can result in output prices firming up. In view of the above, RBI upped its average CPI estimate by 30 bps to 5.4%.

CPI (%)	Jun-23E	Aug-23E
Q1FY24	4.6	4.6
Q2FY24	5.2	6.2
Q3FY24	5.4	5.7
Q4FY24	5.2	5.2
FY24 Average	5.1	5.4
Q1FY25	NA	5.2

*Actual. Source: RBI

Conclusion and Outlook

RBI maintaining the status quo on rates and stance was largely expected. However, introduction of incremental CRR of 10% on change in NDTL (between 19th May 2023 and 28th July 2023 and 29th May 2023) to drain out surplus liquidity (impact is likely to be slightly above INR 1 trillion) was perceived marginally negative and yields at short end rose by 5 to 10 bps. However, RBI emphasised it is a transitory measure (to be reviewed on 8th September 2023 or before) primarily to manage liquidity overhang due to withdrawal of INR 2000 banknotes and reiterated its commitment to ensure adequate liquidity within the system. We believe that the impact of the same is likely to be limited except for keeping overnight rates closer to repo rates in the near term.

Outlook: Since the start of FY24, yields have rallied primarily driven by strong demand for SLR securities from long term buyers. While bonds have given up some gains over the past couple of months, yields are still lower relative to the beginning of the financial year. Further, the longer end yield has rallied more than the shorter end, thus further flattening the curve. Given the liquidity withdrawal measures announced today, the shorter end yields could remain elevated, thus keeping the yield curve flatter for a longer period.

Going forward, we are optimistic on the fixed income market in view of the several favourably placed factors. CPI, especially core CPI, has substantially eased from the peak and is likely to soften further in view of decelerating momentum (excluding temporary impact of vegetable prices), lower input price pressure and benign global commodity prices. Factors like slowdown in services and goods exports, decline in fiscal impulse and soft private consumption are likely to weigh on growth. Further, adequate foreign exchange reserves could keep pressure on INR at bay. Also, in our view, RBI is likely to maintain pause for an extended period and the bar for restarting the rate hike(s) is high.

Key risks to the outlook are robust credit demand, continued global monetary tightening and sustained rise in commodity prices especially oil. Rise in geopolitical tensions, lower Gsec demand from insurance / PF sector and higher supply of state development loans (SDLs) in FY23-24, etc. could also keep the yields at elevated levels.

On an overall basis, in our view, yields are likely to trade in a range with a downward bias. While we continue to recommend investments into short to medium duration debt funds, investors could consider higher allocation to longer duration funds in a staggered manner, in line with individual risk appetite.

Glossary

BPS	Basis points (1 bps = 0.01%)
CPI	Consumer Price Index
CAD	Current Account Deficit
CRR	Cash Reserve Ratio
GDP	Gross Domestic Product
MSF	Marginal Standing Facility
NDTL	Net Demand and Time Liability
OMO	Open Market Operations
PF	Provident / Pension fund
PMI	Purchasing Manager Index
PV	Passenger vehicles
RBI	Reserve Bank of India
SDL	State Development Loans
SDF	Standing Deposit Facility
SLR	Statutory Liquidity Ratio
WPI	Wholesale Price Index
VRRR	Variable Rate Reserve Rep operation

DISCLAIMER

The views of HDFC Asset Management Company Limited, Investment Manager for HDFC Mutual Fund expressed herein as of 10th August 2023 are based on internal data, publicly available information and other sources believed to be reliable. The source for this document is the Bi-monthly Monetary Policy Statement, 2023-24, dated 10th August 2023 published by the RBI. Any calculations made are approximations, meant as guidelines only, which you must confirm before relying on them. The information contained in this document is for general purposes only and is not investment advice. The document is given in summary form and does not purport to be complete. The document does not have regard to specific investment objectives, financial situation and the particular needs of any specific person who may receive this document. The information/ data herein alone are not sufficient and should not be used for the development or implementation of an investment strategy. The statements contained herein are based on our current views and involve known and unknown risks and uncertainties that could cause actual results, performance or events to differ materially from those expressed or implied in such statements. Past performance may or may not be sustained in future.. Neither HDFC AMC and HDFC Mutual Fund (the Fund) nor any person connected with them, accept any liability arising from the use of this document. The recipient(s) before acting on any information herein should make his/her/their own investigation and seek appropriate professional advice and shall alone be fully responsible / liable for any decision taken on the basis of information contained herein.

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