In line with expectations, the Monetary Policy Committee (MPC) of the RBI maintained a status quo on repo rate at 6.50% and the existing stance in its scheduled policy meeting on Oct 6, 2023.

• This marked the fourth consecutive monetary policy of no action on rates accompanied by an unchanged stance since Feb-23.

• 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.
  
• Status quo on rates was unanimously backed by all MPC members, as in the previous meetings.

• The policy stance continued to be retained with the MPC deciding “to remain focused on withdrawal of accommodation to ensure that inflation progressively aligns to the target, while supporting growth”
  

• Like in the previous three reviews, the stance found support from 5 out of 6 members, with Prof. Jayanth R. Varma once again preferring a neutral stance.

Macroeconomic economic outlook

With respect to FY24 economic outlook -

• The RBI retained its GDP growth forecast for FY24 at 6.5% with no alteration in quarterly projections. As such, quarterly growth projections continue to remain at 6.5%, 6.0% and 5.7% for the remaining quarters of FY24. For FY25, Q1 growth was maintained at 6.6%.

• The forecast for FY24 CPI inflation too was held at 5.4%. The quarterly projections saw minor tweaks – with Q2 FY24 CPI inflation forecast revised up by 20 bps to 6.4% and Q3 FY24 estimate revised lower by 10 bps to 5.7%; forecast for Q4 FY24 and Q1 FY25 were maintained at 5.2%.  
  

Key takeaways and outlook

Since the last policy review in Aug-23, the global economic backdrop has turned challenging. Notwithstanding the resilience in US economy, both global growth and trade are on a weaker turf, with the latest rise in energy prices threatening to slow down the inflation descent across the world. This is leading to the expectation that interest rates in US and elsewhere in the developed economies will remain “higher for longer” with significant uncertainty on the pivot timelines.  

In contrast, India has seen growth momentum continuing to remain robust through H1 FY24, supported by strength in domestic consumption, healthy traction in public capex and input costs remaining benign on an annualized basis. On the other hand, retail Inflation appears to have peaked in Q2 FY24 and is expected to moderate over H2 FY24 as the correction in vegetable prices, LPG price cuts, availability of fresh Kharif output and kicking-in of favorable winter seasonality come into play.

Nevertheless, risks to domestic inflation remain stacked on the upside. Several key sub-categories within the food basket – such as cereals, pulses and spices continue to display elevated inflation and kharif yields remain on watch after an uneven end to the monsoon season. Further, the risks of global spillovers from El Nino possibly impacting food production (especially of oilseeds) and geopolitics adding volatility to crude oil prices, remain alive. 

The potential upside risks to headline inflation, in our opinion, have led to a hawkish undertone in the latest policy statement, as it emphatically expresses its intent to actively curb liquidity surplus via OMO sales. Recall, headline liquidity of late has remained in a marginal deficit, though core liquidity remains in the vicinity of Rs 2.8 tn of surplus (as of end of Sep-23). Over the coming weeks, the interplay of ICRR getting reversed (return of Rs 500 bn of liquidity) in second week of Oct-23, along with pick up in Government spending could have been offset by rise in currency in circulation (CIC) amidst the onset of the festive season and impending elections (in select states).

RBI’s announcement of OMO sales albeit without any specific calendar or timelines,  appears somewhat aggressive, but can perhaps be rationalized by three factors –

1. Recent global macroeconomic backdrop: RBI’s move appears well timed alongside the sharp jump in US yields seen over the last few months, reflecting US Federal Reserve’s resolve to maintain rates ‘higher for longer’. In addition, amidst the ongoing strength in USD, RBI’s hawkish bias for domestic interest rates should serve well for preventing build-up of any major depreciation pressures on the INR.
2. India’s inclusion in J.P Morgan bond index: OMO sales could serve well as a forex sterilization tool in case India witnesses a surge in foreign debt portfolio inflows.
3. Could remain ad hoc in usage, depending on evolving liquidity conditions

Keeping the growth-inflation dynamics in mind, we continue to believe that MPC will remain on a prolonged pause, at least until Q1 FY25. 

Outlook on g-sec yields

Post the policy announcement, G-secs sold off with the 10Y bond yield closing the day higher by 13 bps at 7.34%. The usage of OMO sales as a tool to manage liquidity in an active way came as a surprise for market participants. For H2 FY24, we believe that lower g-sec supply alongside moderation in domestic inflation, should keep a lid on 10Y bond yield perhaps around 7.40% levels on the upside in the very near term. Thereafter, possibility of Fed pivot in early 2024, debt inflows ahead of inclusion in global bond index could help push yields lower, perhaps closer to 7.0% by end Mar-24 (against our earlier view of 6.90%).

Additional announcements by RBI:

• Credit Concentration Norms – Credit Risk Transfer: With a view to harmonise the credit concentration norms among NBFCs, it has been decided to also permit NBFCs in the Middle and Base Layers to use CRM instruments for reducing their counterparty exposure under the credit concentration norms.
  

• Gold Loan – Bullet Repayment Scheme – UCBs: The RBI decided to increase the existing limit for Gold Loans under the Bullet Repayment scheme from ₹2 lakh to ₹4 lakh in respect of Urban Co-operative Banks (UCBs) who have met the overall target and sub-targets under the Priority Sector Lending (PSL) as on March 31, 2023.  

Says Suman Chowdhury, Chief Economist and Head-Research “RBI-MPC meeting in early Oct’23 was expected to be a non-event with the continuity in the rate pause and stance. While the latter has played out as per market expectations, MPC has delivered a googly by announcing the use of open market auctions of government securities to absorb liquidity, as and when warranted. The timing is a bit surprising since liquidity is already set to be on the tighter side during the festive season and the upcoming state elections due to higher currency in circulation. In our opinion, OMO will not only help in calibrating liquidity and mitigating inflation risks but also be another tool at the disposal of RBI to control g-sec yields and stabilise the currency. This may be necessary in a period when the US bond yields are at a multi-decade high and global capital flows can be highly volatile.”