11 Aug 2023
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:
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
Key takeaways and Outlook
Our key macroeconomic projections are broadly in-line with that of the central bank:
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.
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.”