Monetary Policy Review: October 2023

The Monetary Policy Committee (MPC) today unanimously decided to keep the policy repo rate unchanged at 6.50%. It also retained its policy stance of “withdrawal of accommodation to ensure that inflation progressively aligns with the target, while supporting growth” with a majority of 5-1 (same as last time). Consequently, SDF, MSF and CRR rates were also kept unchanged at 6.25%, 6.75% and 4.5% respectively. More importantly, Governor in its statement mentioned that RBI may have to consider OMO-Sales to manage liquidity.

On Growth: Global growth and trade moderated sequentially driven by tight monetary policy and continued geopolitical tensions. India’s growth remained resilient with strength visible across many sectors. Industrial and services activity remains robust reflected in strong PMIs, IIP, rising capacity utilisation, cement production, steel consumption, passenger traffic, etc. Domestic demand is also strong resulting in NONG imports elevated. Investment activity remains supported by government thrust on capex.

RBI kept its growth forecast unchanged and expect the demand to sustain supported by buoyant economic activities. Further, recovery in rural demand along with optimistic business and consumer sentiments bode well for economic activity. Improving capacity utilisation and rise in sanctions for projects by banks augurs well for the private investment activity. Further, healthy corporate and banks balance sheets are also supportive of pick up in private capex.

On Inflation: CPI picked up sharply in July and August 2023 on back of broad-based increase in the food prices especially vegetables. While vegetable prices have cooled down sharply, the inflationary pressures from cereals, pulses and spices continue to persist. RBI derived comfort from core inflation trending lower and it being significantly off its recent peak. RBI kept its average inflation forecast unchanged for FY24, although raised its Q1FY24 estimates by 20 bps and reduced Q3 estimates by 10 bps. RBI noted inflation is likely to ease significantly in near term on back of plunge in vegetable prices and cut in LPG prices. Beyond that, risk to inflation emanates from lower pulses sowing, onion output and prices of spices along with spillover impact of global food and energy prices.

Conclusion and Outlook

While RBI maintaining the status quo on rates and stance was widely expected, announcement of conducting OMO Sales to manage liquidity spooked the market. Given the timing and quantum of OMOs targeted are unknown, this step introduces significant element of uncertainty. Further, RBI remained hawkish in its communication with Governor “emphatically reiterating” that inflation target is 4% and not the range of 2%-6%. Post the announcement, yields rose sharply across the curve with yields at longer end rising more (~10-15 bps) than the short end (3-5 bps) and thus, steepening the curve.

Outlook: While there was no change in policy rates or stance, RBI communication was relatively hawkish. By highlighting OMOs Sales explicitly as an active tool for liquidity management, RBI appears to convey its intention to remain “actively disinflationary”, till the time it is confident of achieving its 4% inflation target on durable basis. Going forward, we expect the debt market is likely to be driven by both positive and negative factors.

The key drivers which bode well for decline in yields include:

• Low risk of fiscal slippage, well-balanced demand-supply outlook of government securities and significantly low net supply of SLR securities in H2FY24. Further, robust growth in small saving collections is likely to result in no additional market borrowings even in case of some fiscal slippage. Further, inclusion of India’s sovereign securities in JP Morgan bond index from FY25 bode well for demand outlook for SLR securities and can effectively cap any significant rise in yields.

• CPI and core CPI are likely to trend lower in view of the correction in vegetable prices, decelerating momentum, lower input price pressure and benign global commodity prices. Further inflation expectations remain well anchored and are trending lower.

• Growth rate is expected to trend lower in view of slowdown in services and goods exports, decline in fiscal impulse and softness in private consumption.

• Bar of restart of rate hikes by RBI remains high despite sharp rate hikes by US as adequate foreign exchange reserves should keep pressure on INR at bay. However, RBI is expected to maintain an extended pause for a considerable period of time.

However, there are counter balancing factors which are likely to put upward pressure on yields

• Uncertainty with regard to OMOs sales timing and quantum

• Growth continues to remain robust and if sustained, there is risk of core inflation reaccelerating

• Headline CPI remain susceptible to elevated food price in view of temporal and spatial distribution of monsoon and its impact on crop yields.

• Credit demand remains robust and SLR holdings of banks remain high. Further, the demand from Insurance sector might reduce too compared to last year. Thus, incremental demand from key buyers of G-Secs is likely to remain muted.

• Continued global monetary tightening and risk of rise in commodity prices, especially oil, driven by China reopening and geopolitical dynamics.

• Significant recent increase in global bond yields and rising upside risk to UST yields rising further

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

DISCLAIMER

The views of HDFC Asset Management Company Limited, Investment Manager for HDFC Mutual Fund expressed herein as of 6 th October 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, 2022-23, dated 6 th October 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. 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 and shall alone be fully responsible / liable for any decision taken on the basis of information contained herein.

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