The Monetary Policy Committee (MPC) of the RBI retained the key repo rate at 6.50% in its scheduled policy meeting in the first week of June’23 in line with market expectations of a continuing pause. With this, the lower and upper bound of the LAF corridor – the SDF and MSF rate stand unchanged for the second consecutive meeting at 6.25% and 6.75% respectively.

No action on rates was unanimously backed by all MPC members. The policy stance was retained with the MPC sticking to “to remain focused on withdrawal of accommodation to ensure that inflation progressively aligns with the target, while supporting growth”. Like the outcome in Apr-23 meeting, the stance found support from 5 out of 6 members, with Prof. Jayanth R. Varma to have once again preferred a neutral stance.

Macroeconomic Outlook

There is no material revision in the macroeconomic assessment by RBI MPC: 

• Forecast for CPI inflation was revised lower by 10 bps to 5.1% from 5.2% earlier. On a quarterly basis, CPI inflation is projected at 4.6% in Q1 FY24 (down from 5.1% earlier), 5.2% in Q2 (down from 5.4% earlier), unchanged at 5.4% and 5.2% in Q3 and Q4 respectively.

• The RBI retained its GDP growth forecast for FY24 at 6.5%. On a quarterly basis, forecasts saw a minor tweak with Q1 at 8.0% (revised up from 7.8%), Q2 at 6.5% (up from 6.2% earlier), Q3 at 6.0% (down from 6.1% earlier), and Q4 at 5.7% (down from 5.9% earlier)

Key takeaways and Outlook

The moderation seen in CPI inflation over the months of Mar-23 and Apr-23 along with resilience in domestic growth momentum continuing well into Q1 FY24, appears to have prompted RBI’s decision to pause. Emerging comfort on sustainability of current account deficit and the need for an impact assessment post the aggressive monetary tightening in last one year, are also likely to have played a supportive role. Further, the global economic backdrop since the last policy in Apr-23, has been largely steady with no major negative surprises.

Looking ahead, India’s growth recovery in FY24, is likely to undergo a slowdown. In addition to the spillovers from the anticipated slowdown in global growth and trade, downside risks to growth are likely to stem from – 1) Past monetary tightening weighing on urban leveraged consumption 2) gradual fiscal consolidation and 3) uncertainty with respect to timing of El Nino and it’s possible impact on Southwest monsoon performance. As such, we hold on to our FY24 GDP growth forecast of 6.0%, while expecting some downside risks to RBI’s optimistic estimate of 6.5%. Having said so, a stronger recovery in private capex cycle, nascent signs of which are visible, if turns durable could lead to a minor upward bias to our growth estimate.

On inflation front, the RBI’s downward revision albeit modest, to CPI inflation projection for FY24 by 10 bps to 5.1% is comforting and reinforces that a gradual disinflationary process is well underway. This is broadly in line with our own estimate of 5.3%. However, as acknowledged by RBI itself, geopolitical tensions, uncertainty around the Southwest monsoon and some global commodity prices along with volatility in global financial markets pose upside risks to inflation. These risks preclude a change to our forecast for FY24 CPI inflation for now.

Considering the near-term trajectory of CPI inflation, RBI’s strongly expressed intent to bring inflation back to 4.0% and expectation of residual monetary tightening by some of the major global central bank, we expect MPC to maintain a prolonged pause with the repo rate unchanged at 6.50% the current calendar year. Simultaneously, the RBI would continue to gradually scale back money market liquidity surplus to ensure that inflation progressively aligns with the target and help boost monetary policy transmission. The build-up of transient excess liquidity over the last fortnight or so owing to the withdrawal of Rs 2000 bank note, is likely to be continuously mopped up by RBI. As per comments from the Governor, in his post policy interaction, nearly half of the outstanding stock of the Rs 2000 note (i.e., ~Rs 1.8 tn) is currently back within the banking system as deposits. As such, keeping in mind the uncertain impact of the withdrawal of the Rs 2000 bank note on liquidity, RBI may prefer to use short dated debt instruments rather than opting for instruments having a durable impact on liquidity. We expect the usage of VRRR (variable rate reverse repo) to continue along with the possibility of a sell-buy USDINR swap to manage this transient liquidity upsurge.  

Some Additional Measures:

• Borrowing limits in call and notice money markets: In order to provide greater flexibility to banks, the RBI has permitted Scheduled Commercial Banks to set their own limits for borrowing in the call and the notice money market.

• Widening of the Scope of the Framework for Resolution of Stressed Asset: The RBI has decided to widen the scope of the framework for resolution of stressed assets, under which all the regulated entities including cooperative lenders will now be able to execute "compromise settlements and technical write-offs" to resolve non-performing assets.

• First Loss Default Guarantee (FLDG) in case of fintech lending: Another encouraging development is the decision of RBI to come out with a framework for FLDGs in case of digital lending which will help to reduce the current uncertainty and facilitate higher funding to the sector. 

• Rationalisation of Licensing Framework for Authorised Persons (APs) under Foreign Exchange Management Act (FEMA), 1999: The RBI has decided to rationalise and simplify the licensing framework for APs. This is expected to improve the efficiency in the delivery of foreign exchange facilities to various segments of users including common persons, tourists, and businesses.

Summarises Suman Chowdhury, Chief Economist and Head- Research “On expected lines, RBI MPC has continued with its “pause” on benchmark interest rates and importantly, the stance on “withdrawal of accommodation”. MPC has kept all the options on the table at this stage given that the central banks in several developed economies has continued with moderate rate hikes and there is a lack of clarity on the peak rate and the pivot thereafter. It also sounded relatively hawkish, highlighting that it is not enough for the headline inflation to remain within the tolerance band of 6.0% and it has to subside sustainably below 4.0%.

Clearly, RBI takes into cognizance the upside risks to inflation emerging from the impact of a potential El Nino on monsoon and consequently, on food prices. Nevertheless, RBI has slightly reset its average inflation forecast to 5.1% in FY24 from 5.3% earlier, given the softness in commodity prices and a dilution of supply chain bottlenecks that were seen in the previous year.

RBI 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 latest GDP data of Q4FY23. It has continued to be optimistic on the growth prospects for the current year and kept it pegged at 6.5%.

Given such expectations of the central bank on growth-inflation dynamics, the likelihood of an extended pause on interest rates has increased. In our opinion, any possible rate cut may not materialize before the last quarter of FY24. On the liquidity front, RBI will continue to calibrate the system liquidity appropriately and this is in evidence in the VRRR auctions that had been announced to absorb the additional liquidity in the last two weeks arising primarily due to withdrawal of the Rs 2000 notes.”