RBI Monetary Policy

The Monetary Policy Committee of the RBI decided to hike the policy rate by 25 bps. This will bring the cumulative rate hike in this interest rate cycle to 250 bps. The repo rate now stands at 6.5%, consequently, the standing deposit facility (SDF) rate stands adjusted to 6.25% and the marginal standing facility (MSF) rate and the Bank Rate to 6.75%.

The MPC kept the stance unchanged at withdrawal of accommodation. Four out of six members of the MPC voted to increase the policy rate by 25 bps and remain focused on the withdrawal of accommodation to ensure that inflation remains within the target going forward, while supporting growth.

The RBI started hiking interest rates in May 2022 by front loading rate hikes to tame inflation. Since then, the growth inflation dynamics has turned largely favorable. The headline CPI inflation has moderated from 7.79% in April 2022 to 5.72% in Dec 2022. RBI projects CPI at 5.3% for FY 2023-24. The estimate is below the RBI’s upper band (6%) of the target range but considerably above the 4% target. Few factors such as spike in global commodity prices and supply disruption still persist and can pose as an upside risk to the inflation. The core inflation (CPI ex-food & fuel) continues to remain high and sticky as the pass-through of high input costs to output prices continue to exert pressure on core inflation.

On the growth front, high frequency growth indicators suggest improvement in the economic activity supported by capital expenditure and improvement in private consumption demand. Further, the measures announced in the recent budget for improving employment, consumption demand, capex, etc. should bode well for the economy. RBI projects GDP growth for FY 2024 at 6.4% which is above the market estimate.

The rate hikes done so far are getting transpired in the system and RBI may wait for the impact to be seen in core inflation which remains sticky. The market largely expects a terminal policy rate of 6.5% which may indicate that the rate hike cycle is at its peaked after today’s hike and RBI may take a pause here. However, the governor’s statement does hint that the MPC would retain some room for another hike if headline and core inflation doesn’t subside from here. Also, RBI would keep a close watch on actions of the major global central banks to maintain stability in the forex market. A comforting factor in today’s policy outcome is two out of six members didn’t vote for a rate hike, suggest growing divergence on the policy outcome.

The G-sec yield curve has flattened considerably in the recent past and is expected to remain relatively flat in the near to medium term given expectations of a pause in policy action and neutral liquidity conditions. The net market borrowing of INR 11.8 lakh crore for FY2024 announced in the recent budget was on expected lines and could be absorbed by the market participants along with some support by the RBI via open market operations (OMO). The 10-year G-sec, in the short-term is expected to continue to trade in a tight range of 7.30% to 7.50% in absence of any adverse event.   

At present, the shorter end of the yield curve (upto 3 to 5-year segment) provides better risk adjusted opportunities. The yield curve is nearly flat beyond 5-year segment as the term spread between 10-year G-sec and 5-year G-sec has narrowed to ~10 bps and, hence doesn’t compensate adequately for the duration risk at the current juncture. Corporate bond spreads have compressed meaningfully amid lack of supply in the bond market. The current credit spreads for sub-AAA rated securities are below long term average and may not offer attractive reward for risk.