Monetary Policy Review - October 2024

The Monetary Policy Committee (MPC) voted to keep the policy repo rate unchanged (at 6.5%), with a majority vote of 5 to 1. More importantly, MPC unanimously decided to change the stance to neutral and to remain unambiguously focused on a durable alignment of inflation with the target, while supporting growth. Notably, this was the first MPC post the induction of 3 new external members. One external member (Dr. Nagesh Kumar) dissented and voted in favour of 25 bps rate cut.

Apart from the MPC decision, while RBI governor exuded confidence on Indian banking and NBFC sector on an overall basis, he emphasized on the need to correct and improve their lending practices, risk framework, interest rates charged and executive incentive structure for select Banks, NBFCs and MFIs. Further, he highlighted the need to address the possibility of stress buildup in segments like credit cards, MFIs and loans for consumption purposes.

On Growth: Global growth remains resilient led by services activity although it remains exposed to rise in geopolitical tension and financial markets volatility. Amidst this backdrop, India’s growth remained buoyant aided by healthy growth in investments and consumption. RBI noted that recent indicators suggest growth remains broad based and momentum sustaining. Demand also remains supported by recovery in rural consumption, steady urban demand and higher government spending. Investments is aided by improvement in government capex and private sector.

Source: RBI, MOSPI, *actual

Average growth forecast for FY25 was retained at 7.2%, despite lower than expected growth in Q1FY25. Growth is likely to be aided by pick up in private consumption led by rural sector (in view of above average monsoon and kharif higher sowing), rise in government capex and sustenance of investment activity on back of favourable economic environment and optimism.

On Inflation: Headline CPI decelerated in line with expectations in July-August 2024 on back of favourable base. Food inflation, however, remained relatively high with material inter food group divergence. Core inflation inched up and seems to have bottomed out.

Source: RBI

RBI has retained its average inflation forecast for FY25 at 4.5%. Average inflation for Q2 and Q4 was revised down by 30 bps and 10 bps respectively while that of Q3 was revised up by 10 bps. Key risks to the forecast are prolonged impact of higher vegetable prices, weather related shocks and rise in international food prices sustaining.

Conclusion and Outlook

MPC decision to change the stance to neutral, as opposed to consensus market expectation of no change, came in as a pleasant surprise for fixed income markets and yields rallied by 5 to 10 bps across the curve. While RBI reemphasized the risk to inflation and its resolve to align the same durably to the target, today’s decision has increased the probability of rate cuts by RBI in the coming meetings.

Over the quarter, yield curve has shifted lower and benchmark 10Y Gsec (7.10 GS 2034) yields is now trading ~6.75% (~25 bps lower from end-June 2024 level). This is primarily attributable to favourable SLR demand-supply situation along with start of synchronised easing of major global central banks.

In our view, medium term outlook on Indian fixed income market remains favourable, considering:

• AE central banks have begun to reduce policy rates and RBI is expected to follow soon.
• Central government fiscal deficit is expected to consolidate to 4.9% of GDP (FY24: 5.6%) in FY25 and targets to bring it down to less than 4.5% of GDP by FY26. This could keep market borrowings within manageable levels.
• Additional gain due to higher-than-expected RBI dividend and expectations that it could remain at an elevated level in next year as well and keep Gsec supply under check.
• FPI flows on account of inclusion of India's sovereign securities in JP Morgan global bond indices remains buoyant and might continue in rest of the year. This is further complimented by FPI flows on account of inclusion in Bloomberg EM bond index (expected flows: USD 2 to 3 bn starting Jan-25) and FTSE Russel EM government bond index (USD 4 to 5 bn starting Sep-25).
• Draft circular released on LCR, if implemented, could increase the SLR demand by banks.
• Core CPI momentum remains subdued on back of lower input price pressure. Further, headline CPI is likely to trend towards RBI's target (4%) as pressure from food inflation dissipates in view of good monsoon.
•  External sector remains comfortable in view of steady growth in services exports 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 delaying rate cuts by RBI.
•  Robust credit growth may keep the incremental demand for G-Secs from banks subdued.
•  Significant rise in commodity prices especially oil driven by escalation of geopolitical tensions and/or China stimulus and/or acceleration in global growth.

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, could continue to increase allocation to longer duration funds in line with individual risk appetite. Further, while yield curve has steepened slightly, 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.

DISCLAIMER

The views of HDFC Asset Management Company Limited, Investment Manager for HDFC Mutual Fund expressed herein as of 9th October 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, 2024-25, dated 9th October 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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