By Indranil Sengupta
I remain dovish after two odd years of being a hawk. That said, the RBI expectedly paused yesterday, with growing uncertainty about US inflation and Fed cuts. Although it is plausible that RBI rate cuts typically support the rupee, it is fully understandable that the RBI Monetary Policy Committee (MPC) is reluctant to take chances with the INR at a narrow 1% rate differential with the Fed. While the RBI refers to inflation as the elephant in the room, its monetary policy is driven, like that of all other central banks, by the other elephant — the Fed. In fact, I reiterate that this inflation is yesterday’s story, notwithstanding the hawkish note in the monetary policy. With El Niño set to fade to La Niña, inflation is likely to remain well within the RBI’s 2-6% mandate. On my part, I continue to worry about the rising real repo rate that, at 1.4%, has crossed the 1% deemed neutral. Once the Fed commits to a cut date, it can be safely expected that Governor Shaktikanta Das will begin the rate cut cycle to support growth.
It is expected that the RBI MPC will cut the repo rate by 15 basis points (bps) on August 8, if the Fed commits to its first cut in, say, September, as expected. As the US dollar will then sell off, the RBI’s concerns about the rupee will also abate. Around 100 bps of RBI rate cuts can be predicted by June 2025, with the Fed set to cut 75 bps in 2024.
Also Read Pakistan’s Kashmir Over- Obsession is Suicidal The MV Ruen Episode: Payoffs from Investing in Naval and Air Power Tax burden on a minority: ITR filing has improved, but how long can less than 3% support the rest? The new govt must go in for a speedy rollout of the four codes passed in Parliament I continue to highlight that inflation is yesterday’s story. Inflation can be projected at 4.5% in March and 4.8% in FY25 (4.5% RBI), well within the RBI’s 2-6% mandate. Just as importantly, this is actually lower than the growth-maximising ‘threshold’ inflation of 5.5%. Core inflation has fallen to as low as 2.9%. In fact, I continue to highlight that fundamental factors are not inflationary:
n Limited pricing power: Real gross value added growth is expected to slow down to 6% levels — pretty much around my estimated potential — in 2024 to limit any excessive pricing power.
n Lower agflation: Most weather forecasters expect the El Niño (that drives rain clouds away from India) to fade to La Niña (that drives rain clouds to India) by June. This should cause a normal monsoon to water a bumper kharif autumn crop towards the end of 2024. Rabi/winter sowing has also improved to last year’s levels. Just as importantly, the summer rabi harvest has also ended at 2024 levels, although the rising heat is a risk.
Food minister Piyush Goyal is also taking many steps to limit agflation. The government is selling Bharat rice, Bharat wheat etc. at subsidised rates, taking several measures to augment supply by importing, raising export duty and so on. Prime Minister Narendra Modi has extended the 5 kg monthly limit for free rice/wheat supplied to low-income groups (57% of population) under the National Food Security Act by five years.
n Tight M3 growth: Governor Das has kept a tight rein over money supply growth, at 11.3%, well below the 14.7% average.
Commodity prices should remain well in control with Fed tightening.
Imported inflation is broadly in check with Governor Das’ build-up of FX reserves, ensuring a relatively stable rupee. A forecast of the rupee reaching 82 against the dollar and the dollar trading at 1.16 against the euro by March 2025 is reasonable.
I continue to point out that domestic inflation surely does not warrant a 6.5% repo rate. The real repo rate, at 1.4%, is higher than the 1% seen as adequate in normal times. If the US slows, notwithstanding the recent Fed growth upgrade, is not the ex-post real repo rate at 3.6% with core inflation at 2.9% simply too high? At the RBI’s 4.5% FY25 inflation forecast, the real RBI repo rate is also a high 2%. It is for this reason that the RBI, as well as a number of other EM central banks, are expected to cut rates the moment they receive the green light from the Fed.
It can be predicted that the Fed will cut 25 bps each on September 18, November 7, and December 18 as of now. That said, it was really touch and go between two and three rate cuts in the last Fed dot plot. It is very difficult for the Fed to cut rates unless US core inflation settles at least 0.3% month-on-month (m-o-m) for, say, three months. In my view, if US core inflation is below 0.3% in H2 2024, then there will be 75 bps Fed cut in 2024 and 100 bps RBI cut by June 2025; if US core inflation is 0.3% m-o-m (=3.6% annualised) in 2024, there will be 50 bps Fed cut in 2024 and 100 bps RBI cut by June 2025; if US core inflation is 0.4% m-o-m (4.8% annualised), there will be a Fed pause and 50 bps RBI rate cut by June 2025.
RBI rate cuts will support rather than hurt the rupee as the dollar prices the Fed peak. The relationship between the RBI repo rate and the rupee is different for India. Foreign portfolio investors’ (FPIs) equity holdings are almost 15-20 times those of debt FPIs. RBI rate cuts support growth, attract FPI equity flows, and support the rupee. This, in turn, is crowding debt FPIs) looking for capital/FX gains, especially given JP Morgan/Bloomberg EM Bond Diversified Index inclusions.
Tying this all together, I remain bullish for bonds. The 10-year yield should slip to 6.5% in FY25, taking into account finance minister Nirmala Sitharaman’s fiscal consolidation programme and the RBI’s rate cuts. Estimates suggest that the government securities market should balance with, say, $28 billion of RBI open market operations. Finally, debt will bring in a total of some $27 billion after India’s listing in the JP Morgan/Bloomberg Emerging Markets Bond Index (Diversified).
Indranil Sengupta, Head of India research, CLSA, Views are personal
By Indranil Sengupta
I remain dovish after two odd years of being a hawk. That said, the RBI expectedly paused yesterday, with growing uncertainty about US inflation and Fed cuts. Although it is plausible that RBI rate cuts typically support the rupee, it is fully understandable that the RBI Monetary Policy Committee (MPC) is reluctant to take chances with the INR at a narrow 1% rate differential with the Fed. While the RBI refers to inflation as the elephant in the room, its monetary policy is driven, like that of all other central banks, by the other elephant — the Fed. In fact, I reiterate that this inflation is yesterday’s story, notwithstanding the hawkish note in the monetary policy. With El Niño set to fade to La Niña, inflation is likely to remain well within the RBI’s 2-6% mandate. On my part, I continue to worry about the rising real repo rate that, at 1.4%, has crossed the 1% deemed neutral. Once the Fed commits to a cut date, it can be safely expected that Governor Shaktikanta Das will begin the rate cut cycle to support growth.
It is expected that the RBI MPC will cut the repo rate by 15 basis points (bps) on August 8, if the Fed commits to its first cut in, say, September, as expected. As the US dollar will then sell off, the RBI’s concerns about the rupee will also abate. Around 100 bps of RBI rate cuts can be predicted by June 2025, with the Fed set to cut 75 bps in 2024.
I continue to highlight that inflation is yesterday’s story. Inflation can be projected at 4.5% in March and 4.8% in FY25 (4.5% RBI), well within the RBI’s 2-6% mandate. Just as importantly, this is actually lower than the growth-maximising ‘threshold’ inflation of 5.5%. Core inflation has fallen to as low as 2.9%. In fact, I continue to highlight that fundamental factors are not inflationary:
n Limited pricing power: Real gross value added growth is expected to slow down to 6% levels — pretty much around my estimated potential — in 2024 to limit any excessive pricing power.
n Lower agflation: Most weather forecasters expect the El Niño (that drives rain clouds away from India) to fade to La Niña (that drives rain clouds to India) by June. This should cause a normal monsoon to water a bumper kharif autumn crop towards the end of 2024. Rabi/winter sowing has also improved to last year’s levels. Just as importantly, the summer rabi harvest has also ended at 2024 levels, although the rising heat is a risk.
Food minister Piyush Goyal is also taking many steps to limit agflation. The government is selling Bharat rice, Bharat wheat etc. at subsidised rates, taking several measures to augment supply by importing, raising export duty and so on. Prime Minister Narendra Modi has extended the 5 kg monthly limit for free rice/wheat supplied to low-income groups (57% of population) under the National Food Security Act by five years.
n Tight M3 growth: Governor Das has kept a tight rein over money supply growth, at 11.3%, well below the 14.7% average.
Commodity prices should remain well in control with Fed tightening.
Imported inflation is broadly in check with Governor Das’ build-up of FX reserves, ensuring a relatively stable rupee. A forecast of the rupee reaching 82 against the dollar and the dollar trading at 1.16 against the euro by March 2025 is reasonable.
I continue to point out that domestic inflation surely does not warrant a 6.5% repo rate. The real repo rate, at 1.4%, is higher than the 1% seen as adequate in normal times. If the US slows, notwithstanding the recent Fed growth upgrade, is not the ex-post real repo rate at 3.6% with core inflation at 2.9% simply too high? At the RBI’s 4.5% FY25 inflation forecast, the real RBI repo rate is also a high 2%. It is for this reason that the RBI, as well as a number of other EM central banks, are expected to cut rates the moment they receive the green light from the Fed.
It can be predicted that the Fed will cut 25 bps each on September 18, November 7, and December 18 as of now. That said, it was really touch and go between two and three rate cuts in the last Fed dot plot. It is very difficult for the Fed to cut rates unless US core inflation settles at least 0.3% month-on-month (m-o-m) for, say, three months. In my view, if US core inflation is below 0.3% in H2 2024, then there will be 75 bps Fed cut in 2024 and 100 bps RBI cut by June 2025; if US core inflation is 0.3% m-o-m (=3.6% annualised) in 2024, there will be 50 bps Fed cut in 2024 and 100 bps RBI cut by June 2025; if US core inflation is 0.4% m-o-m (4.8% annualised), there will be a Fed pause and 50 bps RBI rate cut by June 2025.
RBI rate cuts will support rather than hurt the rupee as the dollar prices the Fed peak. The relationship between the RBI repo rate and the rupee is different for India. Foreign portfolio investors’ (FPIs) equity holdings are almost 15-20 times those of debt FPIs. RBI rate cuts support growth, attract FPI equity flows, and support the rupee. This, in turn, is crowding debt FPIs) looking for capital/FX gains, especially given JP Morgan/Bloomberg EM Bond Diversified Index inclusions.
Tying this all together, I remain bullish for bonds. The 10-year yield should slip to 6.5% in FY25, taking into account finance minister Nirmala Sitharaman’s fiscal consolidation programme and the RBI’s rate cuts. Estimates suggest that the government securities market should balance with, say, $28 billion of RBI open market operations. Finally, debt will bring in a total of some $27 billion after India’s listing in the JP Morgan/Bloomberg Emerging Markets Bond Index (Diversified).
Indranil Sengupta, Head of India research, CLSA, Views are personal
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