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RBI Monetary Policy: A surprise pause

06 Apr 2023



  • The Monetary Policy Committee of RBI unanimously retained the key repo rate at 6.50% in its scheduled policy meeting on 6th Apr-23, defying market expectations of a 25bps hike.

  • Although inflation forecast for FY24 saw a minor downward revision, the central bank highlighted that unseasonal rains, elevated core inflation, global financial market volatility and uncertainty regarding crude oil prices continue to pose upside risks to the inflation outlook.

  • Growth forecast for FY24 was also revised upward modestly by 10bps to 6.5% on the back of strong rural demand, resilience in services and government’s enhanced capex spending in FY24.

  • The policy stance remained unchanged with the MPC being “focused on withdrawal of accommodation”. The stance found support from 5 out of 6 members.

  • We expect the central bank to maintain a pause in the near term and gradually scale back liquidity surplus to push monetary policy transmission. However, impact of global economic uncertainties on growth-inflation dynamics keeps the door open for incremental rate hikes in the near future.

  • Amidst the anticipated backdrop of moderation in growth and inflation in FY24, we maintain our 10Y g-sec view of 7.00% by Mar-24.

In an unexpected move, the Monetary Policy Committee of the RBI retained the key repo rate at 6.50% in its scheduled policy meeting on April 6, 2023, defying market expectations of a 25bps hike. With this, the lower and upper bound of the LAF corridor – the SDF and MSF rate stand unchanged at 6.25% and 6.75% respectively.

Interestingly, the rate action was unanimous with all MPC members voting in consensus. Governor Shaktikanta Das remarked that “the decision to pause on the repo rate is for this meeting only” and that “the MPC will not hesitate to take further action as may be required in its future meetings”. The policy stance remained broadly unchanged, focusing on “withdrawal of accommodation to ensure that inflation progressively aligns with the target, while supporting growth”. The stance found support from 5 out of 6 members, with Prof. Jayanth R. Varma likely to have once again preferred a neutral stance.

Macroeconomic Outlook

With respect to FY24 economic outlook -

  • The RBI revised upward its GDP growth forecast to 6.5% from 6.4% earlier. On a quarterly basis, the forecast for Q1 and Q2 was retained at 7.8% and 6.2% respectively, while the revised forecasts stand at 6.1% in Q3 (up from 6.0% earlier) and 5.9% in Q4 (up from 5.8% earlier).
  • Forecast for CPI inflation got revised lower to 5.2% from 5.3% earlier. On a quarterly basis, forecasts saw a minor tweak with Q1 at 5.1% (up from 5.0% earlier), unchanged at 5.4% in Q2 and Q3 each, and 5.2% in Q4 (from 5.6% earlier).

RBI’s growth forecasts for the current fiscal are clearly higher than the average market forecasts as well as our forecast which is pegged at 6.0% for FY24. With the base effect coming into play and the expected moderation in food prices in our base scenario, the headline inflation forecast is fairly consistent with that of ours.

Key Takeaways

Since the last policy review in Feb-23, credit markets in US and Europe tightened on account of turmoil in the banking sector. Although the crisis like situation seems to have got averted with provision of targeted liquidity by the Fed and the ECB (including few other central banks), it could nevertheless impair banking sector’s credit appetite in advanced economies, thereby accentuating the anticipated global economic slowdown. This appears to have provided the primary backdrop for the MPC to opt for a pause in its Apr-23 meeting. Emerging comfort on sustainability of current account deficit, the relative stability of the rupee and the need for impact assessment post the aggressive monetary tightening in last one year, are also likely to have played a role.

Overall, while the pause captures the elements of caution (from global spillovers), comfort (on current account deficit), and evaluation (of past cumulative tightening), RBI’s forecast on GDP growth for FY24 reflects optimism. At 6.5%, this is ~50 bps higher than consensus expectations (as denoted by the Survey of Professional Forecasters). We believe there could be downside risk to RBI’s estimate as domestic pent-up demand is waning even as global uncertainties continue to mount. As such, we maintain our FY24 GDP growth projection of 6.0%. 

On inflation front, consensus expectation, including that from the central bank, points toward the likelihood of moderation in FY24 towards 5.2-5.3% levels. However, upside risks to the outlook continue to emanate from:

  • Despite the expectation of a healthy rabi output, food inflation remains vulnerable to recent unseasonal rains and hailstorms. Price pressure in cereals and spices particularly has been strong and milk prices continue to march ahead at a somewhat elevated pace.
  • The possibility of El Nino disrupting the upcoming south-west monsoon season needs to be closely monitored.

Considering the upside risk to inflation, the inelasticity in core inflation in a 6%+ growth scenario and expectation of residual monetary tightening by the US Federal Reserve, it appears that the MPC prefers to retain policy flexibility by sticking to its ‘withdrawal of accommodation’ stance. This in our opinion has two-fold benefit:

  • The RBI would continue to gradually scale back money market liquidity surplus to ensure that inflation progressively aligns with the target (this is the subtle change introduced in Apr-23 policy stance). In the absence of any proactive liquidity infusion by the central bank, we expect core liquidity (headline adjusted for central government’s cash balances with the RBI) surplus to moderate from Rs 1.28 trillion (as of Mar 24, 2023) to Rs 200 bn before end of Mar-24. Drain on core liquidity would emanate from seasonal demand for cash and reserve maintenance, which would be partially offset by RBI’s FX intervention, maturity of past FX swaps, and transfer of annual dividend

o    While a decline in core liquidity would be a gradual process, the headline liquidity could continue to see volatility. During Apr-23, cumulatively Rs 611 bn of Covid era special liquidity program is due for maturity. Since this would now get refinanced at a higher rate (prevailing repo rate of 6.50%) compared to the 4.40% earlier, this will have a concomitant impact on the money market curve.

o    Refinancing of Covid era liquidity schemes and gradual scale back of core liquidity will help boost monetary policy transmission.

  • In case the tail risks on inflation play out, the central bank could then use the policy flexibility to act and resume interest rate hikes, if required (not our baseline case).

Additional Measures

  • The RBI has proposed to permit banks with IFSC Banking Unit to offer non-deliverable foreign exchange derivative contracts to residents in a bid to deepen the forex market in India and provide enhanced flexibility to residents in meeting their hedging requirements.

  • The RBI proposed to expand the scope of UPI by permitting operation of pre-sanctioned credit lines at banks through UPI.

Impact on G-secs

Since the g-sec market was positioned for a 25 bps hike, the announcement of a pause provided a pleasant surprise with yields declining across the curve. The g-sec curve bull-steepened with yields at the shorter end falling more than the longer end (1Y, 10Y, and 30Y g-sec yield fell by 16 bps, 5 bps, and 4 bps respectively).

The market now perceives the trigger for incremental rate hikes to get activated only if upside risks to inflation crystallize. At this point, the market may presume the repo rate at 6.50% as the terminal rate in the current cycle – thereby taking away some of the uncertainty with respect to the peak of monetary policy cycle. Market participants would now keenly watch for signs of US Fed reaching its terminal rate (widely expected to be in May-23). 

Going forward, the only thing that would keep weighing on sentiment is the record high g-sec borrowing program in FY24. While this would partially offset the comfort from monetary policy, the broader anticipated macro backdrop of moderation in growth and inflation would help pull yields lower during the course of FY24. We maintain our 10Y g-sec view of 7.00% before Mar-24.

Says Suman Chowdhury, Chief Analytical Officer “In our opinion, RBI’s decision to halt any rating action in Apr-23 has been primarily induced by the turbulence in the global banking sector brought about by the failures of a few regional banks in US and the potential contagion risks. In other words, it is “wait and watch” policy being adopted not only on the global environment but also on the domestic inflation print which may respond to the rate actions so far in a lagged manner. What has also helped in taking a pause decision for now is the moderation in the hawkish stance from Fed, weakness in the US dollar and the recent improvement in India’s current account position.

Nevertheless, the communication from RBI has highlighted that the war with inflation is not yet over, the “pause is not a pivot” and the MPC will be ready to take any further hike in rates if the concerns on inflation remain high. RBI has highlighted the potential risks from food inflation given the uncertainty on the current year’s monsoon along with a significant likelihood of the core inflation levels above 6% in the near term due to resilient domestic demand. We believe that the likelihood of a pivot to lower rates in the current year is fairly low.

The pause in the rate cycle, however, will be positive for the bond markets and government borrowings. Despite a higher issuance of gsecs in H1FY24, we don’t expect the 10 yr g-sec yields to move appreciably above the current levels. RBI will also ensure that the liquidity in the system remains either neutral or slightly in surplus which will facilitate the residual monetary transmission and also enable the system to absorb the government borrowing load.”

 Chart 1: Inflation genie is still not inside the bottle