The RBI / MPC kept policy rates unchanged in line with consensus expectations. Thankfully, an outlier risk of stance getting changed didn’t materialise. Further, the general assessment with respect to the growth-inflation trade-off remains relatively benign, thereby indicating little urgency on any rate hikes.
Revised RBI projections on CPI and GDP as below:
The following points are of note from the table above:
- H1 average CPI forecast stands much lower than June projection. This partly reflects lower realised readings in Q1.
- Core CPI forecast for the full year has been lowered by 40 bps to 4.3%, thereby reflecting lower expected generalisation than earlier feared.
Assessment
In line with the above forecasts, RBI / MPC continue to assess that the rise in inflation thus far is mostly on account of fuel and food with little signs of generalisation of price pressures so far. The further rise in headline CPI ahead, peaking in Q3 FY27, is also likely to be primarily due to food and fuel. The MPC specifically notes that inflation is not getting broad-based, core inflation remains moderate and is expected to decline after peaking in Q3. Meanwhile, core inflation excluding precious metals, characterised as ‘underlying inflation’, is likely to align with core inflation towards the end of the financial year.
Growth is seen as resilient thus far but still expected to be lower in the current financial year. Furthermore, the outlook is hazy owing to the monsoons, geopolitics, and global trade policy.
On net, the policy characterisation is one of wait and watch with little urgency on account of any imminent generalisation risks from inflation. If at all a bias is revealed on policy action, it is in the statement: “Any such action would also have to consider the need for recalibration of policy rates in line with the evolving growth-inflation dynamics, especially the normalisation of the underlying inflation from its benign levels seen hitherto.” Simply put, inflation is normalising from very low levels, and therefore the MPC seems to be keeping an open mind that down the line some modest rate hikes may very well be needed. However, the need is not felt yet, so the timing is uncertain. Further, whether the need eventually translates into action or dissipates on its own if inflation generalisation risks continue to not materialise, also seems uncertain at this point.
Takeaways
The RBI / MPC assessment is consistent with our own reading of their reaction function (see, “Re-escalation: A Macro And Bond Update, dated 14th July). Our view on RBI policy remains the same: not more than 50 bps of hikes and not before October. The negative assertion here is intentional since we, like the MPC, aren’t sure whether these 50 bps will also eventually happen or not.
It is to be noted that given the level of market yields for the most part, calibrated 25 – 50 bps hikes eventually may be of little consequence. Rather, what matters more is whether there can be a more sustained alleviation of external account pressures, thereby leading to relief on the rupee, and therefore cessation of the ‘impossible trinity’ dynamic that has been in play for us over the last few quarters. In this regard: 1> the higher than initially expected FCNR flow provides strong temporary cushion, thereby allowing time for more measures to incentivise capital of a more permanent nature into the country, 2> should the AI trade continue to cool off, it may ease dollar strength and pressure on US rates as well as incentivise diversification of capital flows into other geographies like India 3> should recent concerns with respect to pace of capital spending by AI ecosystem companies lead to some spreading out of build out, this will more directly help ease pressures on developed market interest rates.
Our portfolio preference remains for up to 3 – 4 years corporate bonds and 15 – 40 years government bonds. Assuming relevant suitable investment horizons, we think valuations here are very decent. Sustained value unlocking, however, will require continued de-escalation in geopolitical risks, as well as some of the pieces discussed above continuing to fall into place. Money market rates have fallen recently but still look reasonably valued given: 1> higher FCNR flows directly alleviating credit to deposit ratio pressures 2> likelihood of very modest RBI rate hikes if at all.
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