The Reserve Bank of India’s (RBI) Monetary Policy Committee (MPC) maintained the repo rate at 6.5%, with a 4:2 majority vote. This decision reflects the RBI’s ongoing commitment to price stability, which is critical for sustaining long-term economic growth.
The Consumer Price Index (CPI) for April, May, and June 2024 was reported at 4.85%, 4.83%, and 4.75% respectively. However, due to a spike in food inflation, July’s CPI increased to 5.08%. While this suggests that inflation is moderating from its peak, the process is uneven and slow. As a result, the RBI decided to keep the repo rate and its stance of “Withdrawal of accommodation” unchanged.
During the press conference, an intriguing point was made about categorizing inflation as transitional or persistent. The MPC explained that by analyzing the sources of inflation shocks and calculating their persistence, they can better understand how long certain prices take to revert to their mean after a shock. This categorization helps in asserting if it’s transitional or persistent.
Additionally, the economic survey suggested monetary policy cannot control food inflation. The governor expressed the importance of food inflation as it constitutes close to 46% of the CPI basket, individuals understand food inflation relatively easily as compared to other components in the inflation basket. Additionally, food inflation can have second-order effects by contributing to an increase in wage growth and further companies passing the increase to customers thereby effecting headline inflation eventually.
Global Outlook
Globally, central banks are relatively divergent now on the future trajectory of policy rates. Globally financial markets experienced increased financial market volatility due to weaker-than-expected unemployment data. Nonfarm payrolls—a key indicator measuring job creation—came in at 114,000 compared to an expected 176,000, raising concerns about a potential U.S. recession. Despite this, the RBI Governor expressed his opinion as that it would be premature to predict a U.S. slowdown based solely on one month’s data, especially considering the U.S. GDP grew by 2.8% in Q2 2024, compared to 1.4% in Q1 2024.
Debt Investments:
There is a significant gap between banks’ deposit growth and credit growth, potentially leading to asset-liability or liquidity management challenges. As mentioned by the governor, banks would need to leverage their branch networks more effectively to attract deposits. The removal of indexation benefits and the taxation of debt mutual funds at the slab rate may be seen as measures to partly address these issues.
Despite changes in debt taxation, investors shouldn’t disregard debt mutual funds purely from a tax perspective. With inflation largely under control and the RBI expected to cut rates—albeit with a lag behind the Federal Reserve—investors might consider adding duration to their portfolios to benefit from potential positive mark-to-market impacts in a rate-cut scenario. Depending on risk appetite, a tactical allocation of 20% to 40% of the fixed-income portfolio towards longer-duration instruments could be considered. Additionally, the lack of tax deduction at source on debt funds vis bank deposits continues to make them efficient from a compounding perspective for long-term investors in debt instruments.
Equity Investments:
Equity markets across various capitalizations are currently trading at expensive valuations. Large-caps are trading at more favorable valuations compared to small and mid-caps. We recommend trimming allocations in small and mid-cap stocks and tilting portfolios towards large caps. Additionally, an underweight position of at least 10% on equities is advisable vis a vis your strategic mix.
As a result of increased global volatility on the back of Japanese Yen carry trade, Israel-Iran conflict concerns, and weak US unemployment data, domestic indices have retracted from their recent peaks as below:
Data as of August 8th, 2024.
Loans:
For loans linked to the repo rate or other external benchmarks, re-pricing would occur in line with any changes in the repo rate. Estimates suggest a Repo rate cut from the December 2024 MPC meeting. EMIs if linked with the repo rate could get lower going ahead accordingly.
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