The Monetary Policy Committee of RBI raised repo rate by 50 bps to 5.90% in its scheduled policy meeting on 30 Sep-22, in line with market consensus. This marked the third hike of 50 bps on the trot, taking the cumulative rate hike to 190 bps since May-22. With the latest move, the lower and upper bound of the LAF corridor stand adjusted upwards to 5.65% and 6.15% respectively.

The rate action was however not unanimous this time, as one of the six MPC members (Dr. Ashima Goyal) voted for a lower quantum of rate hike i.e., of 35 bps. The policy stance however remained unchanged with the MPC committing to “remain focused on withdrawal of accommodation to ensure that inflation remains within the target going forward, while supporting growth”

Macroeconomic Economic Outlook

With respect to FY23 economic outlook -

• RBI lowered its FY23 GDP growth forecast by 20 bps to 7.0%. On a quarterly basis, it now expects higher growth in remaining three quarters versus previous estimates at: – 6.3% for Q2 (6.2% earlier), 4.6% in Q3 (up from 4.1% earlier) and 4.6% in Q4 (4.1% earlier). The forecast for Q1 FY24 was also revised up to 7.2% from 6.7% earlier.
• On CPI inflation, RBI has retained its FY23 forecast at 6.7%. On quarterly basis, forecast for Q3 saw a marginal tweak to 6.5% from 6.4% earlier, followed by unchanged projection for Q4 at 5.8% and 5.0% for Q1 FY24.

Key takeaways and outlook

Since the last policy meeting in Aug-22, global economic environment has seen a marked deterioration. Most central banks have turned even more hawkish in commentary in a bid to tame inflation and in action by aggressively hiking rates. Against the backdrop of persisting war and its repercussion on trade and growth, the tightness in global financial conditions have further dented global growth prospects. The Governor alluded to this as the third major shock – “a storm” to the global economy – after the pandemic and war.

Against this backdrop, the downward revision to RBI’s growth forecast to 7.0% - is marginally lower than our projection of 7.2%. However, we do attach downside risks to our outlook on account of - 

• Buildup of adverse global factors (like tightening of global financial conditions, elevated geopolitical uncertainty, etc.) would constrain external demand significantly in H2 FY23.

• Likelihood of government resorting to some degree of back-loaded expenditure rationalization in order to stick to the FY23 fiscal deficit target of 6.4% of GDP.

On inflation front, from a global perspective, India is benefitting from the moderation seen in global commodity prices since early Jun-22.

• The Reuters CRB Index (representing price of a generic commodity basket) was down by ~11% in Sep-22 compared to its peak in Jun-22.

• Crude oil prices have slipped below USD 90 pb. RBI too lowered its estimate for India Crude Basket average for FY23 to USD 100 pb from USD 105 pb earlier.

• The FAO food price index has corrected by close 13.1% over Jun-Aug-22, the pass-through of which is visible on edible oils in the domestic market

Having said so, there are also upside risks to food inflation, despite the Southwest monsoon season ending in a surplus rainfall of 6% (vs. LPA) stemming from –

• Lower acreage of Rice and pulses by 5.5% and 3.9% respectively versus last year.
• Onset of festive season demand along with some speculative trading are both conjectured to be weighing on prices of cereals. Price for rice and its derivatives have already begun to harden in domestic market. In early Sep-22, Government enforced a ban on export of broken rice and the imposition of a 20% export duty on non-basmati rice exports.
• Extension of PMGKY by 3 months up to Dec-22 at the time when cereal prices are reeling under pressure..
  
• Intense rain spells seen in some states could have an impact on price of perishables especially vegetables. Price of Tomatoes, as per high frequency mandi data, have already firmed up by 34.8% sequentially in Sep-22.

With systemic liquidity slipping into deficit recently, RBI indicated that it would conduct only fortnightly 14-day variable rate repo operations to streamline liquidity towards the guidance level or 1.5% of NDTL. In RBI’s assessment, core liquidity remains in surplus (at around 2.2% currently, as per our estimate) due to high government cash balances. The liquidity drained out on account of GST and advance tax outflows, forex outflows along with the sharply increased credit growth, would be partly made up for by typically higher Government spending in H2.

At a macro level, external account may offer some discomfort amidst an elevated trade deficit and a sizeable deficit estimate of USD 50 bn for FY23 BoP (1.4% of GDP). This coupled with the increased dollar strength is likely to continue to weigh on Rupee with moderate incremental depreciation being penciled in. The Governor in his policy statement, did indicate that “over the medium term, the primacy of price stability embedded in our flexible inflation targeting (FIT) framework provides the anchor for exchange rate stability”. This highlights the importance of a stable currency in inflation moderation with higher interest rates and the resultant normalization of interest rate differentials with developed economies set to act as a cushion against currency volatility.

Taking all these factors into account, we expect the MPC to hike repo rate by 35 bps in Dec-22, to take repo rate to 6.25%. While there is a scope for further rate tightening, it will be a function of the pace of the global growth slowdown and the domestic inflation trajectory over the next two quarters.

Chart 1: RBI raises the repo rate by 50 bps for the third consecutive time

 Chart 2: Banking system liquidity gradually moderates to ~Rs 2.3 tn in Aug-Sep’22