RBI Shifts to Neutral Stance: What This Means for Indian Equities
This week, the Reserve Bank of India (RBI) took a significant step in adjusting its monetary policy. After holding interest rates steady at elevated levels for 20 months and maintaining its stance of “withdrawal of accommodation,” the latest Monetary Policy Committee (MPC) meeting has shifted the stance to “neutral.” This signals a potential change in the central bank’s future approach, hinting at possible rate cuts on the horizon.
Factors Behind the Shift
The RBI retained its FY25 forecasts for GDP and CPI inflation at 7.2% and 4.5%, respectively. However, the GDP estimate for the September quarter was slightly reduced from 7.2% to 7%, while subsequent quarters are projected to see better performance. CPI inflation for Q2 is also expected to come in at 4.1%, lower than the previously estimated 4.4%.
This slight reduction in growth and inflation estimates reflects the economy’s softer-than-expected performance. High-frequency indicators such as passenger vehicle sales and the manufacturing Purchasing Managers’ Index (PMI) also hint at a slowdown. As a result, the RBI deemed it appropriate to shift its stance to “neutral,” preparing for future rate cuts that could support growth in line with revised projections.
Despite this shift, the RBI has kept its policy rate unchanged, emphasizing its commitment to bringing inflation down to 4%. The central bank cited risks from weather disruptions, geopolitical tensions, and global inflationary pressures, keeping them cautious.
This change follows the U.S. Federal Reserve’s recent rate cut, underscoring the importance of maintaining attractive yield spreads between Indian and U.S. treasuries, which influences foreign investor behavior.
Implications for Indian Equities
A shift to a neutral stance lays the groundwork for the RBI to initiate rate cuts, likely before the end of the year. Lower rates should theoretically boost borrowing and spending, fueling economic growth and potentially lifting the stock market. However, in practice, rate cuts are often accompanied by stock market corrections, due to delayed transmission effects and liquidity constraints.
Globally, rapid rate hikes by central banks, including the U.S. Fed and RBI, have led to a narrowing of yield spreads between U.S. and Indian bonds. This resulted in foreign institutional investor (FII) outflows from Indian equities, totaling over Rs. 4 lakh crore. Although the U.S. Fed’s rate cut temporarily widened yield spreads, an RBI rate cut might halt this trend and encourage further FII outflows, especially as China’s economic stimulus continues to divert investment away from India.
What Should Investors Do?
Despite significant FII outflows, Indian equities have shown resilience, largely due to strong domestic institutional investor (DII) support. DIIs have injected nearly Rs. 8 lakh crore into the market, pushing indices to record highs. Behind this are retail investors, whose enthusiasm for stock markets has risen recently, often at market highs. The key question is whether these investors will stay invested through market corrections.
India’s long-term growth prospects remain solid, and any short-term market dips could present opportunities for investors to buy into fundamentally strong companies at more favorable valuations. While near-term volatility might persist, the broader outlook for Indian equities remains positive.
The image added is for representation purposes only
