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RBI Monetary Policy : No clarity yet on a pause

08 Feb 2023



o    In line with consensus expectations, the Monetary Policy Committee of the RBI raised repo rate by 25 bps to 6.50% in its scheduled policy meeting on 8th Feb-23. This takes the cumulative hike in repo rate to 250 bps since May-22.

o    With the latest move, the lower and upper bound of the LAF corridor – the SDF and MSF rate stand adjusted upwards to 6.25% and 6.75% respectively.

o    Although average inflation forecast for FY23 saw a downward revision to 6.5% and for Q4FY23 to 5.6%, the central bank highlighted that core inflation continues to remain sticky around 6% levels.

o    Despite 2 out of 6 MPC members voting for a pause in policy tightening, the remaining 4 members continue to sound collectively hawkish.

o    The policy stance remained unchanged with the MPC continuing to be “focused on withdrawal of accommodation”. The stance found support from 4 out of 6 members.

o    We expect the RBI to persist with monetary tightening given the persistence in core inflation at elevated levels. This leaves the door open for yet another 25 bps hike in Apr-23 with shift in stance becoming data dependent. This apart, RBI will continue to calibrate the liquidity level appropriately to bring down the surplus levels further. 

In line with our and market expectations, the Monetary Policy Committee of the RBI raised repo rate by 25 bps to 6.50% in its scheduled policy meeting on 8th Feb-23 to “keep inflation expectations anchored, break the persistence of core inflation and thereby strengthen the medium-term growth prospects”. This marked the sixth consecutive hike in repo rate since May-2022 and the first in the current calendar year, taking the cumulative increase to 250 bps. With this, the lower and upper bound of the LAF corridor – the SDF and MSF rate stand adjusted upwards to 6.25% and 6.75% respectively.

Once again, the rate action was not unanimous, as two of the six MPC members (Dr. Ashima Goyal and Prof. Jayanth R. Varma) voted against the repo rate hike. The policy stance remained unchanged with the MPC committing to “remain focused on withdrawal of accommodation to ensure that inflation remains within the target going forward, while supporting growth”. The stance found support from four out of six members.

Macroeconomic Outlook

With respect to the economic outlook -

  • RBI released its FY24 GDP growth forecast at 6.4%, roughly in line with estimates by the Economic Survey and Union Budget. On quarterly basis, it expects growth at 7.8% in Q1 (revised up from 7.1% earlier), 6.2% in Q2 (revised up from 5.9% earlier), 6.0% in Q3 and 5.8% in Q4 with risks evenly balanced.
  • On CPI inflation, RBI lowered its FY23 forecast by 20 bps to 6.5%.  with Q4 forecast tweaked downwards to 5.7% from 5.9% earlier. For FY24, projection for Q1 and Q2 remained unchanged at 5.0% and 5.4% respectively. Overall forecast for FY24 was introduced at 5.3%, along with Q3 FY24 at 5.4% and Q4 at 5.6%

Key takeaways and Outlook

Since the last policy review in Dec-22, CPI inflation has descended lower from peak levels seen around mid-2022, driven by easing food prices, waning global supply chain disruptions and moderation in global commodity prices. While the impact of tightening of financial conditions is yet to transmit fully, a step down in the quantum of rate hike by the RBI indicates that the bulk of monetary policy aggression is over. Against this backdrop, the downward revision to RBI’s FY23 inflation forecast to 6.5% is comforting.

Having said so, inflation is unlikely to fall to the medium-term target of 4.0% anytime soon and there are upside risks to inflation on account of -

  • While food inflation witnessed a downward trajectory over the last three months aided by fresh mandi arrivals, the downward trajectory in food inflation may dissipate with the summer season uptick in the coming months. Price pressure in cereals and spices particularly have been strong and milk prices continue to march ahead at a somewhat elevated pace.
  • Consolidated fuel prices have been firm, with bulk of the increase coming from hike in kerosene prices along with hardening of coke, charcoal, and dung cake prices.
  • Core CPI inflation is likely to remain elevated around 6% levels, deterring RBI to end the current tightening cycle.

Domestic economic activity is expected to find support from the sustained focus on capital and infrastructure spending as indicated in the Union Budget 2023-24, along with a commitment to fiscal consolidation which is likely to crowd-in private investment. However, RBI’s GDP growth projection for FY24 at 6.4% appears somewhat optimistic as impending slowdown in global growth and lagged impact of cumulative rate hikes done by the central bank is yet to play out completely. As such, we expect FY24 GDP growth marginally lower at 6.0%.

From policy perspective, there are two key implications:

  • Despite two out of the six MPC members voting for a pause in policy tightening, the remaining four members continue to sound collectively hawkish.
  • Having said so, as the MPC becomes more reactive (i.e., data dependent) with incremental leaning on a neutral stance, and most importantly, the step down in monetary aggression (from 35 bps rate hike earlier to 25 bps now), leads us to believe that tightening cycle in policy rate is surely close to its peak if not there completely.

The retention of policy stance by the MPC leaves the door open for yet another 25 bps hike in Apr-23. However, this may not be necessarily accompanied by a shift in policy stance as the MPC may prefer to retain policy flexibility and err on the side of caution amidst risks from still elevated core inflation. The RBI may continue to hike repo rate beyond Apr-23 if sticky core CPI inflation persists and the US Fed reassesses its rate trajectory with a hawkish bent.

Liquidity Scenario

RBI had taken a flexible approach to liquidity management by undertaking both variable rate reverse repo (VRRR) and variable rate repo (VRR) operations over the last few quarters as per requirement. As a result of all these measures, the real policy rate has come in positive territory and the banking system has gradually moved out of the whirlpool of excess liquidity.

While liquidity remains in surplus, with an average daily absorption of ₹1.6 Lakh Cr under the LAF in January 2023, it has come down materially from the levels of Rs 7 Lakh Cr in Apr-22. However, as we approach the fiscal year end, the liquidity scenario is expected to get tighter due to tax outflows, higher seasonal demand for cash and also scheduled redemptions of LTRO/TLTRO.  

Additional measures:

  • Introduction of Securities Lending and Borrowing in Government Securities: The RBI will allow banks to borrow and lend government bonds in a move that could add depth and liquidity to the market. This facilitates wider participation in the securities lending market by providing investors an avenue to deploy idle securities and enhance portfolio returns.
  • Climate Risk and Sustainable Finance: RBI plans to put up a broad framework for acceptance of green deposits, disclosure frameworks on climate-related financial risks and guidance on climate scenario analysis and stress testing for banks.
  • Expanding the Scope of TReDS: The RBI has proposed to expand the scope of activities of the Trade Receivables Discounting System (TReDS) to provide insurance facility, allow entities undertaking factoring business as financiers, and enable secondary market operations. This move will facilitate the financing of trade receivables of MSMEs and improve their cash flows.

Says Suman Chowdhury, Chief Analytical Officer, Acuité Ratings & Research “RBI MPC has hiked its benchmark repo rate by 25 bps in line with market expectations but unexpectedly, has continued its stance at “withdrawal of accommodation”, maintaining a hawkish tone in its statement. There is no indication of any pause in the rate hike and the likelihood of further moderate hikes in the repo rate remains, depending on the upcoming data prints. While the headline inflation print has seen a downward trajectory and has remained below the upper MPC limit of 6% in Nov-Dec’22, MPC continues to have concerns on the core inflation levels and has declared its intent to “break the persistence of high core inflation”. On the growth front, RBI appears to be relatively optimistic by forecasting GDP growth at 6.4%, higher than our forecast of 6%. It also believes that the global growth environment has slightly improved with the latest global data indicating higher prospects of a soft landing.

The liquidity in the system has remained slightly in surplus in the last 2-3 months but with most liquidity enhancement measures of the pandemic period having been withdrawn along with the seasonal tax outflows and demand for cash, it may switch to a neutral or a slightly deficit position, thereby putting pressure on short term rates.

We expect lending and deposit rates to move up further in the near term by 50 bps across most banks. Retail loans including home loans will accordingly be repriced and may have some impact particularly on real estate demand.”