Monetary Policy Review - August 2024

The Monetary Policy Committee (MPC) voted to keep the policy rate and stance unchanged, with a majority vote of 4 to 2, same as last time. Hence, repo rate was maintained at 6.5% and stance remained focussed on “withdrawal of accommodation to ensure that inflation progressively aligns to the target, while supporting growth”. Consequently, SDF, MSF and CRR rates were also kept unchanged at 6.25%, 6.75% and 4.5% respectively. Notably, 2 external members continue to dissent and voted in favour of 25 bps rate cut and changing the stance to neutral.

With regard to financial stability, governor in his speech highlighted 4 major issues – (1) rising dependence of banking system on short term non-retail deposits and need to attract deposits through innovative products and service offerings, (2) need for assessment and calibration of underwriting standards in view of increasing household leverage through retail loans, (3) channeling of top-up home loans for speculative purposes, and (4) importance of robust business continuity plan in view of recent IT outage globally.

On Growth: While global growth and inflation momentum has moderated recently, India’s growth continues to remain resilient. The business activity remains healthy reflected in buoyant manufacturing and services PMIs and industrial production. Consumption also remains steady on the back of rural recovery and robust urban consumption. Further, investments continue to grow at a healthy pace supported by government infrastructure thrust and pick up in private capex spending.

GDP Growth (%)	Jun-24E	Aug-24E
Q1FY25	7.3	7.1
Q2FY25	7.2	7.2
Q3FY25	7.3	7.3
Q4FY25	7.2	7.2
FY25	7.2	7.2
Q1FY26	NA	7.2

Source: RBI, *MOSPI, actual

RBI maintained its average growth forecast for FY25, although Q1FY25 growth forecast was revised down by 20 bps on the back of lower-than-expected growth in corporate profitability and government spending during the quarter. Overall, growth is likely to remain healthy supported by optimism on agricultural activity in view of well progressing monsoon and sowing along with steady services activity and urban consumption.

On Inflation: The headline CPI inched up primarily on the back of broad based increase in food inflation led by vegetables, pulses and edible oil. The fuel inflation remained negative on YoY basis because of LPG price cuts, while core CPI remained muted.

RBI kept its average inflation forecast for FY25 unchanged at 4.5%, despite upward revision in Q2 and Q3 forecast by 60 bps and 10 bps respectively. RBI noted that near term food inflation momentum remains high and is likely to offset, to a certain extent, the favourable base effect.

CPI (%)	Jun-24E	Aug-24E
Q1FY25	4.9	4.9*
Q2FY25	3.8	4.4
Q3FY25	4.6	4.7
Q4FY25	4.5	4.3
FY25 Average	4.5	4.5
Q1FY26	NA	4.4

Source: RBI, *actual

Further, the revision in telecom tariffs, rise in inflation expectations, surveys pointing at likelihood of rise in selling prices could put upward pressure on CPI. Notably, RBI Governor reemphasized importance of food inflation in inflation expectations and reasoned that sustained high food inflation can spill over to core inflation through expectation channel and thus, monetary policy considerations should factor that in as well.

Conclusion and Outlook

Today's status quo policy was in line with expectations and no measures to drain out liquidity was viewed marginally positively by market participants. However, revision in the quarterly inflation forecast and reemphasis on food inflation importance in determining policy direction was perceived slightly hawkish and dampened expectations of early monetary easing given the weakness in global fixed income markets. Overall, Gsec yields were largely unchanged post the policy.

Over the past couple of months, yields have moved lower and benchmark 10Y Gsec yields is now trading below 6.9% (~15 bps lower than end-June 2024) partly reflecting favourable SLR demand and supply situation and global risk-off sentiments triggered by weakening in US labour market.

In our view, fixed income remains favourably placed over the medium term, considering:

• Global growth is increasingly showing signs of slowdown and AE central banks (notable exception being US Fed) have begun to reduce policy rates and RBI is also expected to cut policy rates in H2FY25.
• Central government fiscal deficit is expected to consolidate to 4.9% of GDP (FY24: 5.6%) in FY25 and target of bringing down it to less than 4.5% of GDP by FY26 remains unchanged. This should keep market borrowings within manageable levels.
• Additional gain due to higher-than-expected RBI dividend and expectations that it can remain at an elevated level in next year as well.
• Inclusion of India's sovereign securities in JP Morgan global bond indices bodes well for demand outlook for G-Sec in FY25. Further, draft circular released by RBI on Liquidity Coverage Ratio (LCR) which, if implemented, can increase the SLR demand by banks.
• Core CPI momentum remains subdued on back of lower input price pressure.
• External sector remains comfortable in view of steady growth in services exports, fall in oil prices and adequate foreign exchange reserves.
• Revision of India's sovereign rating outlook to positive (Rating unchanged at BBB-) from stable by S&P enhances the possibility of rating upgrade for India in next couple of years.
   

Key risks to the favourable outlook

• Regular food price shocks keeping headline CPI at an elevated level
• Robust credit growth and elevated SLR holdings can keep the incremental demand for G-Secs from banks subdued.
• Significant rise in commodity prices especially oil driven by escalation of geopolitical tensions

Overall, in our view, yields are likely to trade with a downward bias and the long end of the yield curve is likely to outperform over the medium term. Thus, as highlighted in past, investors with a relatively longer investment horizon, may continue to increase allocation to longer duration funds in line with individual risk appetite. Further, while yield curve has steepened slightly, it is still relatively flat and in view of elevated short-term rates along with expectations of rate cuts in H2FY25, one may also consider investment in short or medium duration categories of debt funds.

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
PMI	Purchasing Manager Index
RBI	Reserve Bank of India
SDF	Standing Deposit Facility
SLR	Statutory Liquidity Ratio
AE	Advanced Economies

DISCLAIMER

The views of HDFC Asset Management Company Limited, Investment Manager for HDFC Mutual Fund expressed herein as of 8th August 2024 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 8th August 2024 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. HDFC Mutual Fund/HDFC AMC is not guaranteeing/ offering/communicating any indicative yields or guaranteed returns on investments made in the scheme(s). 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.

 

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