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RBI Monetary Policy: Pause continues with slightly more hawkishness

11 Aug 2023



  • In line with expectations, the RBI maintained status quo on policy rate (repo rate at 6.50%) and stance (‘withdrawal of accommodation’) in its scheduled policy meeting on Aug 10, 2023.

  • The RBI, nevertheless, surprised by announcing a hike in reserve requirement, with banks required to maintain Incremental CRR of 10% on the increase in NDTL between May 19, 2023 – Jul 28, 2023. As per our estimates, this will impound Rs 936 bn of liquidity that accrued largely from the return of the Rs 2000 bank notes. The decision is temporary and will be reviewed by Sep 8, 2023.

  • The central bank retained its forecast for FY24 GDP growth at 6.5%, while revising up its CPI inflation forecast by 30 bps to 5.4%.
  • We broadly concur with RBI’s growth-inflation forecasts and expect the MPC to ignore the temporary spike in vegetable prices, while being vigilant on inflation risks.
  • We continue to expect a prolonged pause from the MPC through FY24. This is likely to be accompanied by a hawkish undertone to ensure complete monetary transmission and discourage formation of premature policy pivot expectations.

  • While we see some near-term pressure for 10Y g-sec yield, it is likely to moderate towards 7.00% levels by Mar-24, if there is no unexpected turn in the headline inflation. 

Along expected lines, the Monetary Policy Committee (MPC) of the RBI maintained status quo on policy rate and stance in its scheduled policy review meeting on Aug 10th, 2023. As such:

  • Repo rate (last changed in Feb-23) continues to remain at 6.50%.

  • “Withdrawal of accommodation to ensure inflation progressively aligns with the target, while supporting growth” continues to underscore the policy stance

The voting pattern within the MPC also saw a status quo. While the ‘no change’ rate action was backed by full majority, the stance found support from 5 out of 6 members, with Prof. Jayanth Varma continuing to prefer a neutral stance.

Notwithstanding the widely anticipated status quo on policy rate and stance, the RBI however surprised by announcing a hike in reserve requirement for banks. With effect from fortnight beginning Aug 12, 2023, banks will be required to maintain Incremental CRR (I-CRR) of 10% on the increase in NDTL between May 19, 2023 – Jul 28, 2023. As per our estimates, this will result in the central bank impounding Rs 936 bn from Rs 3.78 trillion worth of core liquidity (estimated for week ending Jul 28, 2023). RBI wanted the banks to park a larger proportion of their surplus liquidity in longer term instruments like Variable Rate Reverse Repo (VRRR) but it was only getting parked in Standing Deposit Facility (SDF). The decision is temporary and will be reviewed on Sep 8, 2023 (or earlier) with a view to returning the impounded funds to the banking system ahead of the festival season. 

Macroeconomic projections by the RBI

  • The RBI retained its FY24 GDP growth forecast of 6.5%. On a quarterly basis, the projected GDP growth continues to remain at 8.0%, 6.5%, 6.0%, and 5.7% for Q1, Q2, Q3, and Q4 respectively. Further, the growth forecast for Q1 FY25 was introduced at 6.6%. 

  • Forecast for FY24 CPI inflation was expectedly, revised up by 30 bps to 5.4% given the push from higher food prices starting from Jun-23. On a quarterly basis, projection for Q2 and Q3 were revised up by 100 bps and 30 bps, to 6.2% and 5.7% respectively, while it was retained at 5.2% for Q4. The change in forecast for Q2 was particularly sharp in the backdrop of the increase in prices of certain vegetables apart from the continuing concerns on the prices of cereals and pulses. Further, the inflation forecast for Q1 FY25 was introduced at 5.2%.

Key takeaways and Outlook

Our key macroeconomic projections are broadly in-line with that of the central bank:

  • While we have been maintaining our FY24 GDP growth forecast of 6.0% on account of global slowdown risks and lagged impact of monetary tightening done by the RBI, we have also highlighted the possibility of some upside to this estimate. The agriculture sector output, which would be contingent upon the El Nino outturn and its impact on the distribution of the monsoon, would potentially determine the extent of upside. Meanwhile, gradual improvement in domestic demand conditions with active support from public capex would continue to drive economic growth in the coming quarters.

  • On the inflation front, the revised projection by the RBI at 5.4% is marginally ahead of our existing forecast of 5.3%. This appears to have incorporated the significant flare-up in tomato prices (as per high frequency mandi price data, tomato prices jumped by a record 215% MoM in Jul-23), which could potentially push headline CPI inflation towards 6.6-6.7% in Jul-23.

o    The impact of unseasonal rains earlier in the year, delayed onset and unevenness of Southwest monsoon and certain instances of pest attacks have collectively impacted the supply of tomatoes. However, with multiple cropping cycles, tomato supply should start responding favorably from Sep-23 onwards (there is early indication of prices plateauing in various zones – in fact the latest price is ~7% below its peak seen on Aug 4th).

We believe in mean reversion of volatile vegetable prices and hence concur with the MPC to look through the temporary spike in inflation on this account. Having said so, we also acknowledge that since the current food price shock (led by tomatoes) is a massive outlier in the data series, it would impart a minor upside risk to our FY24 CPI inflation forecast of 5.3% (some upside risk could also emanate from hardening of crude oil prices in recent weeks and continued inter-temporal and spatial unevenness in monsoon performance). We will review our forecast with quantification of upside risk post the release of Jul-23 CPI data later this month.

Against this backdrop, it’s necessary to ensure that the guard against inflation is not lowered and stakeholders’ expectations are aligned with the purported disinflationary path, leading towards the 4% target over the medium term. The temporary I-CRR hike should be seen in this context as it would help curb core liquidity surplus from its existing level of 2.0% of NDTL to 1.5% of NDTL (broadly considered as the inflationary threshold, for further explanation on this point, you can refer to the article in our website published on June 30, 2023 “Role of liquidity management in India’s management policy”: https://www.acuite.in/Market_Liquidity_Thematic_Jun-23.htm). It would also discourage the formation of market expectations with respect to a premature policy pivot. 

While we acknowledge the need for RBI to maintain a hawkish undertone in the near term, we do not expect the need for incremental rate hikes. With nominal repo rate at 6.50%, the ex-ante real policy rate is projected to be ~1.5% by the end of FY24. This appears reasonable for an economy which is exhibiting signs of stability post the Covid shock. As such, we continue to expect the MPC to remain on an extended pause through FY24.

The near-term hawkishness coupled with likelihood of an extended pause should flatten the yield curve with short term rates staying elevated, while 10Y g-sec yield could remain range-bound (7.10-7.30%) in the coming months. Having said so, we maintain our call of a moderation in 10Y yield towards 7.00% levels by Mar-24 as market positioning starts building ahead of the actual pivot in monetary policy in FY25.

Additional Measures:

  • Regulatory framework for financial benchmarks: All financial benchmarks will be reviewed based on a comprehensive risk-based framework to enhance governance.
  • Review of regulatory framework for NBFC-IDFs (Infrastructure Debt Funds): With the objective of channelizing funds for infrastructure, the relaxed framework for NBFC-IDFs envisages: (i) withdrawal of the requirement of a sponsor for the IDFs, (ii) permission to finance Toll Operate Transfer (ToT) projects as direct lenders, (iii) access to ECBs, and (iv) making tri-partite agreement optional for PPP projects. This is expected to support easier refinance of the debt in completed infrastructure projects.

  • Greater transparency in interest rate reset of EMI based Floating Interest Loans: To minimize communication gaps between lender-borrower and usher in best practices in the EBLR regime, the revised framework envisages lenders to clearly communicate with the borrowers for resetting the tenor and/or EMI, provide options of switching to fixed rate loans or foreclosure of loans, along with transparent disclosure of various charges incidental to the exercise of these options.


  • Next-gen UPI payments for furthering digital penetration: It has been proposed to launch ‘Conversational Payments’ on UPI, that will enable users to engage in a conversation with an AI-powered system to initiate and complete transactions in a safe and secure environment. This channel will be made available in both smartphones and feature phones-based UPI channels.

  • Public tech platform for frictionless credit: A digital Public Tech Platform is being developed by the Reserve Bank Innovation Hub to enable delivery of frictionless credit by facilitating seamless flow of required digital information to lenders. The end-to-end digital platform will have an open architecture, open APIs and standards, to which all financial sector players can connect seamlessly in a ‘plug and play’ model. This shall bring about efficiency in the lending process in terms of reduction of costs, quicker disbursement, and scalability. Over the longer run, such a platform, if executed well, can pose competition to the business models of both banks and NBFCs.

Says Suman Chowdhury, Chief Economist and Head- Research, Acuité Ratings & Research “On expected lines, RBI MPC has continued with its “pause” on benchmark interest rates for the third consecutive time in August and also retained the stance on “withdrawal of accommodation”. But the Governor sounded slightly more hawkish, highlighting that headline inflation needs to subside sustainably below 4.0% and any surge in the inflation print, if continued for a longer period, may necessitate fresh action. The hawkish stance is also reinforced by the unexpected announcement on an incremental CRR (ICRR) of 10% on the incremental NDTL over the last 3 months which will help in absorbing a large part of the excess liquidity created through the return of the Rs 2000 notes and the large dividend to the government from RBI. Nevertheless, it has been stated that the need for the ICRR will be reviewed next month and may be done away with depending on the credit requirements during the festive season.  

Clearly, RBI takes into cognizance the upside risks to inflation emerging from higher global food prices accruing from adverse climate events and also the recent hardening in crude oil prices. MPC has further revised its average inflation forecast to 5.4% in FY24 from 5.1% earlier, due to the sharp rise in vegetable prices in the current quarter and its potential impact on the average inflation in Q2, the forecast of which has been revised sharply to 6.2%. However, RBI also believes that such a rise in food prices should be temporary and should get corrected by Q3, given the expectation of a largely normal monsoon.  

The central bank has also taken note of the steady if not strong growth undercurrents in the domestic economy as observed from the high frequency indicators and the healthy industrial performance in the first four months of the current fiscal. It has continued to be optimistic on the growth prospects for the current year and kept it pegged at 6.5%. 

Given the uncertainty on the inflation front, the likelihood of an extended pause on interest rates has been reinforced. In our opinion, any possible rate cut may not materialize before the last quarter of FY24. The liquidity will be slightly tighter than expected in the near term due to the ICRR imposition and this may lead to an increase in short term rates. 

Another encouraging development is the decision of the central bank to come out with new steps to facilitate better access of funds to the infrastructure NBFCs (NBFC-IDFs) and the announcement of an open architecture for access to credit in India in the lines of ONDC which can have a longer term impact on the business model of banks and NBFCs.”