The MPC changed stance to neutral in line with our expectation (https://bandhanmutual.com/article/17416 ). The accompanying commentary, while acknowledging better balance on inflation versus growth, was somewhat cautious, largely reflecting recent global developments. While repo rate was kept unchanged, there was one dissent from new external member Nagesh Kumar who voted for a cut.
Assessment
The stance change is unambiguously positive as it implies higher confidence to cut policy rates in the future, even as it was never a necessary condition for MPC to start to do so. The confidence is exhibited in the language used with the Governor noting that “developments since the August meeting of the MPC indicate further progress towards realising a durable disinflation towards the target”. Core inflation is expected to be broadly contained even as it may have bottomed out, while food price outlook has improved despite near term pressures. The latter reflects good kharif sowing, adequate buffer stocks, and good soil moisture conditions which are conducive for rabi sowing. Risk factors to inflation include unexpected weather events and worsening of geopolitical conflicts. Also noted are the recent uptick in food and metal prices that, if sustained, can add to upside risks.
The optimism on growth continues with the global economy expected to remain resilient (though with downside risks from geopolitics), healthy agricultural prospects supporting consumption, improved consumer and business confidence, resilient non-food bank credit growth, elevated capacity utilisation, healthy balance sheets of banks and corporates, and the government’s continued thrust on infrastructure spending.
RBI projections for growth and inflation are summarised below:
From the October 2024 Monetary Policy Report:
CPI structural model estimates - Average FY26 = 4.1% (same as in Apr24 MPR) with Q1 FY26 = 4.3%, Q2 FY26 = 3.7%, Q3 FY26 = 4.2%, Q4 FY26 = 4.1%
Real GDP structural model estimates - FY26 = 7.1% (up from 7% in Apr24 MPR) with Q1 FY26 = 7.3%, Q2 FY26 = 7.2%, Q3 FY26 = 7%, Q4 FY26 = 7%
Takeaways
With the stance change out of the way, market will now look forward to the first rate cut. We continue to think that this is likely in the next monetary policy review scheduled for December. However, ours (and we suspect MPC’s) confidence around this would have been higher had the recent turn in geo-politics not happened. As things stand, if the recent upturn in global commodity prices sustains then it is possible that the first rate cut gets delayed to February 2025. On the other hand, if these were to stabilise or the disinflation in local food prices is stronger, then there will be no point delaying the cut. This is especially so because we continue to think that the RBI may be a shade too optimistic on growth. As of now the recent slower data (core industries, GST collection, auto sales, etc.) is in general commentary being chalked up to excess rainfall, inauspicious period for purchases, etc. However, if these end up not accounting for all of the slowdown, then RBI will also have to take note of this in its growth projection.
At any rate, the direction of travel is fairly clear and one should not fret the exact timing so much. Markets anyway tend to run ahead of the action and unless something material happens to change expectations, we expect the cycle cut pricing to continue to proceed as far as bond yields are concerned. We continue to believe that there are distinct structural elements to India’s bond view with the additional sweetener being cycle top on rates and compulsive valuations. We will follow up with a note covering some of these aspects in the next few days even as the policy discussion takes up much of the page space today.
Strategy
The corporate bond curve remains inverted given the ongoing pressures on banks’ credit / deposit ratio. As this gets resolved and RBI commences monetary easing, the shape of this curve should normalise. Thus, the so-called sweet spot, or where the maximum fall in yields can happen, is actually the front end of the corporate curve (upto 2 years). However, the problem is that this doesn’t provide enough duration for investors. On the other hand, the government bond and SDL curves are already positive sloping and hence investors can position at adequate duration points here without worrying about any inversion to be corrected first.
We continue to believe that the best way to build duration is via government bonds. In many fund strategies we are using front end corporate bonds / money market for carry and to benefit from eventual curve normalisation, while using government bonds to build duration. We reiterate that the number one risk facing investors is reinvestment risk and that this has to be plugged with appropriate duration selection.
Source: RBI and Bandhan internal research
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