Amidst a challenging economic environment marked by slowing growth and elevated inflation, the Monetary Policy Committee (MPC) adopted a balanced approach by keeping policy rates and stance unchanged while easing banking liquidity through a 50 basis points (bps) cut in the Cash Reserve Ratio (CRR). Revised growth and inflation projections for FY25 stand at 6.6% and 4.8%, respectively, signaling a tilt towards supporting growth. With inflation expected to moderate close to 4% in FY26, a policy rate cut in February 2025 appears likely, especially if growth disappoints further.
Key Highlights and Decisions
Policy Rates:
- Repo rate remains unchanged at 6.50% (4 out of 6 MPC members voted for status quo, 2 favored a 25 bps cut).
- Standing Deposit Facility (SDF) rate at 6.25%; Marginal Standing Facility (MSF) rate and Bank Rate at 6.75%.
Monetary Stance:
The MPC maintained its neutral stance while prioritizing inflation alignment with targets and supporting growth.Growth and Inflation Outlook:
- FY25 CPI inflation: Revised upwards to 4.8% (from 4.5%).
- Q3FY25: 5.7%; Q4FY25: 4.5%.
- FY25 GDP growth: Revised down to 6.6% (from 7.2%).
- Q3FY25: 6.8%; Q4FY25: 7.2%.
- FY25 CPI inflation: Revised upwards to 4.8% (from 4.5%).
CRR Adjustment:
The CRR was reduced by 50 bps to 4% in two tranches to ease banking liquidity, effective December 14 and December 28, 2024.Foreign Capital Measures:
Interest rate ceilings on FCNR(B) deposits have been relaxed until March 31, 2025, to attract capital inflows.Market Development:
Introduction of a new benchmark rate, Secured Overnight Rupee Rate (SORR), to enhance interest rate derivative markets and improve benchmark credibility.
Balancing Growth and Inflation Amid Uncertainty
The policy announcement comes amid significant global and domestic headwinds:
- Global Factors: Uncertainty post the U.S. elections caused U.S. Treasury yields to spike before stabilizing. A stronger dollar led to pressures on emerging market currencies.
- Domestic Challenges: Q2FY25 GDP slowed to 5.4%, significantly below expectations. Inflation rose sharply in September and October 2024 due to food prices, while core inflation remained subdued. Banking system liquidity faced a deficit amid RBI's forex interventions and tax outflows.
Given these conditions, the MPC’s cautious approach to rates while addressing liquidity through a CRR cut was expected.
Economic Projections and Challenges
- Growth: Achieving the projected 6.6% GDP growth for FY25 appears ambitious. For H2FY25, GDP growth would need to average 7%, a tall task given subdued government spending, global uncertainties, and fiscal constraints.
- Inflation: Headline CPI inflation rose to 6.2% in October 2024, driven by food prices. Inflation is expected to remain elevated at 5.5%-5.7% in Q3FY25 but should moderate in Q4FY25 and align with the 4% target by FY26, aided by improved food supply conditions.
Liquidity Management: RBI’s Proactive Measures
Liquidity turned into a deficit in late November 2024 due to capital outflows and forex interventions. To counteract this, the RBI’s 50 bps CRR cut will inject approximately ₹1.16 lakh crore, supporting liquidity transmission. While near-term liquidity may remain tight, the RBI is expected to remain flexible with operations like variable rate repo (VRR).
Market Reaction and Outlook
- Bond Market: The 10-year G-Sec yield initially fell by 15-17 bps post-Q2FY25 GDP data but corrected 4-7 bps after the policy announcement due to unwinding of trades. Short-term yields declined 1-3 bps as the CRR cut met expectations.
- Future Outlook: A policy rate cut in February 2025 appears likely as growth risks intensify and inflation realigns to targets. However, global factors, including pressure on the Indian Rupee (INR), could limit the MPC’s ability to ease policy.
Investment Strategy: Favorable Risk-Reward for Debt Markets
The policy has set the stage for an easing cycle, presenting opportunities for investors:
- Shorter Maturity Bonds: To benefit from improving liquidity.
- Longer Tenures: Expected rate cuts and strong demand-supply dynamics make them attractive.
Investors may consider allocations to Gilt Funds, Medium Duration Funds, Corporate Bond Funds, and Banking & PSU Funds, while remaining cautious about global risks like crude price volatility and geopolitical uncertainties.
Conclusion
The MPC’s measured approach reflects a delicate balancing act between growth concerns and inflation management. With the economy expected to stabilize and inflation moderating in FY26, a rate cut in February 2025 appears imminent. Investors stand to benefit from strategic allocations in debt markets amid favorable risk-reward dynamics.
Comments
Post a Comment