Financial conditions constrained by liquidity and capital outflows

• CRISIL’s Financial Conditions Index (FCI) shows India’s overall financial conditions tightened in January compared with December
• The FCI fell to 0.5 in January from 0.7 in December. A lower FCI value indicates tighter financial conditions, and vice versa
• Liquidity went into deeper deficit, putting upward pressure on short-term rates. Financial conditions were also affected by foreign portfolio investors (FPIs) turning net-sellers
• But as liquidity tightened, the transmission of interest rate hikes improved across lending and deposit rates in January. However, the cumulative rise in most lending and deposit rates remains lower than the Reserve Bank of India’s (RBI’s) 250 basis point hikes since May 2022. Overall bank credit growth has been largely unaffected by the rise in lending and deposit rates so far
• Incomplete transmission of monetary policy prompted the RBI to keep interest rates unchanged and continue its withdrawal of accommodation stance. We believe the central bank will be active in liquidity management and regulatory measures to prevent excesses in credit growth. We expect this to moderate gross domestic product (GDP) growth by next fiscal year. We foresee the RBI cutting rates from June 2024