Informist, Monday, Jun 5, 2023
By Shubham Rana and Aaryan Khanna
NEW DELHI - A confluence of favourable economic indicators supports the Reserve Bank of India's rate-setting committee's call to stay put on interest rates, at least till the end of the financial year in March.
India's GDP data for the March quarter, released Wednesday, surprised everyone on the upside. At 6.1%, GDP growth in Jan-Mar was much higher than the consensus estimate of 5.1%. The stronger-than-expected growth figures coincide with moderating headline inflation, which fell to an 18-month low of 4.7% in April.
Policy watchers are now increasingly comfortable with the narrative that the RBI's Monetary Policy Committee can afford to keep the repo rate at 6.50% for the rest of the current financial year, with inflation moving closer to its medium-term target of 4% and growth still buoyant.
"Given the evidence today, a rate move towards either side is very unlikely without very strong evidence," said Aditya Vyas, economist, STCI Primary Dealer. "My earlier estimate, before the GDP figure came out, was rate cuts might happen in Jan-Mar. But now, that estimation has been pushed back by one quarter."
High frequency data prints show that the growth momentum is continuing in the current financial year.
India's manufacturing Purchasing Managers' Index, compiled by S&P Global, rose to a 31-month high of 58.7 in May while the services Purchasing Managers' Index remained above 61 for the second consecutive month. Both data sets suggest upbeat demand conditions.
The only blip is India's index of eight core industries, which grew at a six-month low of 3.5% on year in April. However, that has more to do with the continued poor performance of the petroleum and natural gas sectors and a contraction in electricity generation due to sharply lower summer temperatures in northwest India in May.
The rate-setting panel had decided to keep the repo rate unchanged at 6.50% at its April policy, but RBI Governor Shaktikanta Das was quick to state that this was just a pause and not a pivot. The next policy review will start Tuesday and the decisions will be announced on Thursday.
The governor's comments and the MPC's decision to continue with its stance of withdrawal of accommodation likely stem from fears of the financial markets running ahead of themselves and starting to factor in interest rate cuts, which is the case with the overnight interest rate swap market.
Financial markets are typically far ahead of rate cycles. This has held true for certain periods since April, when the pause in the MPC's rate cycle hastened bets on a rate cut as soon as October.
In the US, there has been a wild swing in expectations on rates since March, with high inflation and tight labour market conditions persisting. Traders in the US now see a rate cut closer to the end of 2023 or beyond from the earlier expectation of multiple rate cuts this year. The RBI's rate cut actions are seen lagging those of the US Federal Reserve by at least a month.
To be sure, US rates are seen at their peak or near it. However, hasty policy rate cuts seem unlikely, as evidenced by recent comments of US Federal Open Market Committee members. Rather than a rollback of their aggressive policy steps over the past 15 months, members have suggested a further policy tightening may be necessary.
Back home, the Monetary Policy Committee has so far stayed away from even discussing the possibility of rate cuts, either in public or in the minutes of its policy statements. The closest acknowledgement of a soft policy so far has been the central bank governor's statement, patting the rate-setting panel on its back for its decision at the April policy review.
"This (April retail inflation of 4.7%) gives me and my colleagues in the RBI reasonable amount of confidence, I would say good amount of confidence that the monetary policy is on the right track," Das had said after the release of the inflation data.
SWAP RATES
The optimism on rate cuts has ebbed in the rate swaps market, first pushing rate cut bets to December and now, after the GDP print, even later to the February policy meeting. There is only one rate cut of 25 basis points fully priced into the 1-year OIS contract that matures on Jun 6, 2024, according to rates traders.
This span includes the five remaining policies in 2023-24 and at least one in the next fiscal year.
The 12-month swap rate acts as a benchmark for the near-term rate view, as the most liquid contract of the OIS curve under five years. The contracts maturing in early December and March are trading much above the Mumbai Inter-bank Offered Rate of 6.44% - the floating leg of the most-traded category of interest rate swaps.
The 1-year OIS rate ended Friday at 6.56%, with the six-month swap rate at 6.58% and the nine-month swap rate at 6.59%. This puts the median rate view closer to February than December, accounting for compounding effects and higher rates paid to offset risk in longer tenure contracts.
"Nobody was talking about rate cuts in 2023, I was probably the most aggressive earlier to even say Jan-Mar," said Vikas Goel, managing director and chief executive officer, PNB Gilts. "I think rate cuts can now be pushed back to the next financial year."
With the MPC likely to settle on a repo rate of 6.50% this week, no quick reversal is on tap to rectify a potential overshoot of the terminal rate that some analysts had expected, traders said. Since the week after the April policy, short-term rates have remained in a narrow band, with rate cut hopes moving back in lockstep with the calendar.
OUTLIER VIEW
While the Jan-Mar GDP print is a big positive with respect to India's growth momentum, the figures are ultimately backward-looking. Some traders, particularly offshore participants in the swap rate markets, continue to bet on a quick rate cut, from both the US Fed and subsequently the MPC, as the impact of rate hikes so far is likely to have sapped the demand from the economy.
This has prevented OIS rates from moving towards reflecting an April 2024 rate cut, even as domestic participants move gradually towards a later moderation in rates.
The main reason why market participants are looking at rate cuts is worry over the sustenance of the country’s growth momentum in the face of a global economic slowdown.
"We remain less sanguine on the ability of the Indian economy to bypass the incoming global headwinds. As DM (developed market) central banks continue to raise policy rates to rein in inflation, and with weaker China growth offering lesser counterbalance, we believe global growth slowdown will continue," Nomura said in a report.
Nomura expects a total of 75 bps of rate cuts in India, starting October. Nomura has reiterated its outlier view for months now, with a note in January first pegging the start of rate cuts in August. "Past episodes of global downturn have disrupted not just India's export cycle, but also its capex cycle," it said.
While the current macroeconomic situation may not prompt the MPC to consider rate cuts in the near future, monetary policy conditions are almost surely expected to ease in the first half of 2024-25.
Inflation is expected to be close to RBI's mandated 4% by then, which would provide the MPC enough space to think about cutting rates, economists said. According to the central bank's own estimates, CPI inflation is expected to average 4.5% in 2024-25.
This would put the real interest rate, the rate of return over and above the expected rate of inflation, at 2%. While there is no official view of the central bank on real interest rates, at least two external members of the MPC--Jayanth Varma and Ashima Goyal--have said that in the current economic scenario, a real rate of around 1% should be sufficient to bring inflation down.
For now, cues on rates will come on Thursday, when the central bank details the decisions of the rate-setting panel at the monetary policy review. End
Edited by Ranjana Chauhan
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