Opinion
Markets to watch MPC voting pattern for perspective of new external members
Summary
- The markets had been bracing for some period of stability as Fed commenced big with a sharper-than-expected 50 bps rate cut and crude oil prices hovered near the lowest levels since early-2022. But the resurgence of the Middle East tensions has raised doubts on the sustainability of optimism.
The upcoming October 7-9 monetary policy committee (MPC) decision will come in the backdrop of three new external members joining the committee and, once again, added uncertainty from the re-emergence of geopolitical risks. The markets had been bracing for some period of stability as Fed commenced big with a sharper-than-expected 50-basis-point rate cut and as crude oil prices hovered near the lowest levels since early-2022. However, the recent resurgence of the Middle East tensions has raised doubts on the sustainability of optimism.
The ongoing global disinflationary trend and the consequent comfort on continued monetary easing will need to be reassessed in case the geopolitical risks were to magnify. While some jitteriness has been felt across all asset classes (including oil), the sensitivity of oil prices to geopolitical risks has remained weak over the past two years. Needless to say, this sensitivity could again be revived if the conflict were to escalate and pose major risks to supply. The central banks, globally, will need to remain watchful of ongoing developments.
Read more: World War 3 looms? The ultimate checklist for Indian investors
While rising crude prices will be a point of worry for the MPC, for now we do not consider this as an alarming situation. Further, the oil companies’ marketing margins remain higher than ₹10/litre for both petrol and diesel, providing adequate cushion to cap upside risks to prices.
The domestic inflation trajectory seems to be trending broadly in line with expectations even as food price volatility remains. While the MPC had revised up the Q2FY25 inflation estimate by 60 bps to 4.4% in the August meeting, we were expecting some downside to these estimates given the softening of food prices in July-August, despite the telecom tariff hike (Kotak: 4.2% in Q2FY25).
However, the sustained surge in vegetable prices, although likely to be temporary, is expected to keep the next 2-3 readings closer to 5%, before winter arrival of crops begins easing the price pressures. Overall, for FY25 we continue to expect the inflation average at 4.5%, with FY26 average likely to trend towards 4%.
Given the global uncertainty and elevated food prices in the near term, we expect the MPC members to keep their focus on the last leg of disinflationary trends intact in the upcoming policy. Further, despite the softer-than-expected Q1FY25 GDP data (RBI at 7.1% compared to 6.7% actual outturn), the internals remained comforting, which could further provide room to the MPC to hold on to the policy rates for now.
Having said that, the drivers are gradually shifting towards a softer monetary policy stance in India. Global monetary easing cycle is already underway and commodity prices have remained well in check (barring the recent risks from oil price spike and China’s stimulus). We expect the global economic slowdown to become more pronounced in the coming quarters with spillovers to domestic growth. Consequently, even as RBI’s recent bulletin suggests FY25 and FY26 GDP growth at 7.3% and 6.7%, respectively, we expect downside risks to prevail. Further, the RBI projects FY26 inflation to moderate to 3.9% (from 4.6% in FY25), with sub-4% estimates from Q2FY26.
Read more: Bad omens for India’s goods exports
The RBI has already allowed a gradual easing in financial conditions over the last quarter. The weighted average call rate (WACR), along with other overnight segments, has drifted lower by 8-10 bps in Q2FY25 given comfortably surplus liquidity conditions. RBI’s regular use of VRR/VRRR to balance the downside and upside to overnight rates has also comforted the markets. While RBI in the February 2024 policy had explicitly delinked the liquidity stance with the policy stance, we believe that the central bank will still need to manage the two suitably in order to ensure smooth monetary policy transmission.
The continued fine tuning of liquidity operations by RBI to align overnight rates closer to the repo rate is a soft signal for the central bank being ready for stance change to neutral in the upcoming policy. However, repo rate cuts may still have to wait. While we see scope for repo rate cuts beginning from December, the recent geopolitical risks and its fallout on supply constraints may defer the actions further.
Meanwhile, markets now await the perspectives which the new external MPC members will bring to the table. Although much of the opinions will be known only during the minutes of this meeting, any divergence in voting patterns in the policy will provide markets enough food for thought!
The author is the chief economist, Kotak Mahindra Bank. The views and opinion expressed in the column are personal and do not necessarily reflect the opinion of the organisation or the Kotak Group.
