In line with market expectations, the Monetary Policy Committee of the RBI raised repo rate by 35 bps to 6.25% in its scheduled policy review on 7th December 2022 to “break core inflation persistence and contain second round effects”. This marked the fifth consecutive hike in repo rate since May-2022, taking the cumulative increase to 225 bps. With this hike, the repo rate has climbed back to the level last seen in Feb’19 i.e. around 3 years ago. The lower and the upper bound of the policy rate corridor – the Special Deposit Facility (SDF) and the Marginal Standing Facility (MSF) rate, also stand revised upwards to 6.00% and 6.50% respectively.

As in the last MPC meet, the rate action was not unanimous and it was backed by a 5-1 majority vote from the MPC, with one member voting for a pause. The policy stance also remained unchanged, remaining focused on “withdrawal of accommodation, while supporting growth”. The stance found support from 4 out of 6 members, with the remaining two likely to have preferred a shift to neutral stance in our opinion.

Macroeconomic economic outlook

With respect to FY23 and FY24 economic outlook -

• The RBI has revised lower its FY23 GDP growth forecast slightly to 6.8% from 7.0% earlier. On quarterly basis the revised forecasts stand at 4.4% in Q3 FY23 (down from 4.6% earlier), 4.2% in Q4 FY23 (down from 4.6% earlier), and 7.1% in Q1 FY24 (down from 7.2% earlier). The forecast for Q2 FY24 was introduced at 5.9%.
• On CPI inflation, the forecast for FY23 CPI inflation was retained at 6.7%. On quarterly basis, forecasts saw a minor tweak with Q3 FY23 at 6.6% (up from 6.5% earlier) and Q4 FY23 at 5.9% (up from 5.8% earlier). The forecast for Q1 FY24 was retained at 5.0% while that for Q2 FY24 was introduced at 5.4%.

Key takeaways and outlook

Since the last policy review in Sep-22, global growth risks have intensified. Tightening of financial conditions, subdued prospects for international trade, and persistent geopolitical uncertainty continue to weigh upon consumer and producer confidence. Against this backdrop, the downward revision to RBI’s FY23 growth forecast to 6.8% is not surprising.

On inflation front, our expectations are in line with RBI’s FY23 projected CPI inflation of 6.7%. However, we do acknowledge that minor downside to projected inflation in H1 FY24 has started to emerge, especially on the non-core front:

• Increasing threat of a severe global slowdown along with tight financial conditions is pulling most commodity prices lower. The Reuters CRB Index (representing price of a generic commodity basket) is down ~11% in Dec-22 compared to its peak in Jun-22. More importantly, crude oil prices are currently trading at their lowest levels in calendar 2022 with Brent at around USD 76 pb.
• The FAO food price index dropped to 135.7 in Nov-22 from its record high of 159.7 in Mar-22, marking a ~15% decline. For domestic market, the pass-through of this has begun to get visible, esp. in case of edible oils.

However, core inflation continues to remain sticky above 6% levels due to a steady recovery in domestic demand. While lagged pass-through from the anticipated disinflation in non-core inflation should help anchor expectations along with the moderation in food inflation with kicking in of favorable winter seasonality and ongoing pick-up in rabi sowing, any sustainable subsidence of the headline print below 6.0% may take a few months.

From policy perspective, there are two key implications:

• Despite 2 out of 6 MPC members now likely to vote for a pause in the next policy review in Feb-23, the remaining 4 members continue to sound collectively hawkish. This leaves space for further tightening.
• Having said so, the comfort on projected inflation trajectory for the next 4-quarters, growing divergence within the MPC with incremental leaning on the dovish side, and most importantly, the step down in monetary aggression (from 50 bps rate hike earlier to 35 bps now), leads us to believe that policy rate is getting close to peak.

As such, we now expect the MPC to opt for 25 bps rate hike in Feb-23, before getting into a pause mode for impact assessment.

Additional measures:

• SLR Holdings in Held to Maturity (HTM) category: The RBI has extended the dispensation of enhanced HTM limit of 23% up to March 31, 2024, to provide flexibility to banks in managing their investment portfolios. Extension of Bank’s HTM limits will be restored to 19.5% from 23% in a phased manner starting from the quarter ending June 30, 2024. This will help the banking sector to reduce the MTM losses in their books and also facilitate fresh investment in g-secs.
• Hedging of Gold in the International Financial Services Centre (IFSC): Resident entities will now be permitted to hedge their gold price risk on recognized exchanges in the IFSC.

Concludes Suman Chowdhury, Chief Analytical Officer, Acuité Ratings & Research

“Beyond the 35 bps rate hike which was largely expected, we believe that RBI has taken a moderately hawkish stance at this point in time with continuation of its stance of “withdrawal of accommodation” which implies that further rate hikes may take place in the upcoming policy meets if the inflation print continues to be above RBI’s expectations.

Essentially, the MPC has kept faith on the resilience of the domestic economy and has only marginally revised its GDP growth forecast to 6.8% in FY23 despite the increased global headwinds. This is consistent with our view that domestic demand has seen a healthy momentum in the current year and is likely to sustain given the expected recovery in rural demand. In particular, the high credit growth of 17% YoY and incremental credit of Rs 10.6 lakh cr disbursed in Apr-Oct’22 has been highlighted as an indication of domestic demand. Given the moderately healthy growth momentum , RBI remains cautious on the headline inflation print and will keep an “Arjuna’s eye” on it, highlighting its intent to bring it sustainably down to below 6% within the next two quarters. This opens up the possibility of a further round of rate hike in Feb-23 and a potential terminal rate 6.5% by the beginning of FY24. RBI has also made it clear that liquidity calibration will continue to take place and market participants have to get used to a lower level of liquidity surplus in the system.

Acuité expects a further rise in bank deposit rates over the next two quarters to the extent of 50-100 bps given the narrative from MPC and the continuing momentum in credit growth. The pass through of higher rates to home loans may start to impact the demand for housing particularly in the mid to high ticket segment.”

Annexure

Chart 1: Normalization of the Policy Corridor