J.P. Morgan On India Inflation Outlook & RBI Liquidity Operations

J.P. Morgan maintains modest upside risks to India's inflation outlook, in an updated view post Friday's RBI decision. They also expect the central bank to manage liquidity as we progress through 2024, particularly amid passive bond inflows (related to GBI-EM bond index inclusion), see below for more details.

" The tone of the policy was expectedly hawkish with the Governor noting the RBI had identified “high inflation as a major risk to macroeconomic stability and sustainable growth” and the MPC statement indicating “monetary policy needs to remain actively disinflationary.” To be sure, the statement took comfort from the easing of core inflation in recent months. However, the MPC is rightfully concerned about food inflation risks, in part because of the patchy and uneven monsoon, with the statement noting, “The MPC observed that the unprecedented food price shocks are impinging on the evolving trajectory of inflation and that recurring incidence of such overlapping shocks can impart generalisation and persistence.”

"Finally, the RBI’s inflation forecasts were largely unchanged. The RBI’s October-March inflation forecast is 5.4%, a tad lower than J.P. Morgan’s 5.5% forecast. That said, we believe the risks to our forecast are skewed to the upside on account of food price pressures."

"The expressed desire to keep liquidity contained and potentially use OMO sales as a sterilization tool also reinforces our view of the macroeconomic implications of inclusion in J.P. Morgan’s Bond Index. As we had previously indicated, to the extent that index-driven debt flows drive a larger balance of payment (BoP) surplus next year, the RBI can be expected to actively intervene to prevent Rupee appreciation – as has been the central bank’s revealed preference – and thereby create commensurate Rupee liquidity. To the extent that this excess liquidity would need to be sterilized through OMO sales, for example, this would simply result in a swap on the RBI’s balance sheet away from Net Domestic Assets (NDA) to Net Foreign Assets (NFA), with commensurate implications for the bond market."