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Nifty stumbled on a more hawkish than expected RBI hike

RBI may hike further by +25 bps each in February and April for a terminal rate of +6.75%

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India’s benchmark stock index Nifty surged soon after RBI hiked all effective policy rates by +0.35% as expected by the market, which is a step down from earlier +0.50%. The RBI repo rate is now at +6.25%, at its highest level since Aug’18. Some market participants were also expecting a clear message of pause by RBI after the December hike. But RBI didn’t convey any message of pivot (pause) and telegraphed another smaller hike @0.25 bps in the coming months by keeping ‘Arjuna’s eye’ on the evolving inflation dynamics.

In brief, RBI is very upbeat on India’s economic growth but quite cautious on sticky core inflation, still hovering around +6.00%; substantially above +4.00% targets and also at the upper tolerance band. Thus RBI may continue to hike +0.25% on 8^th February and further +0.25% in April’23 for a terminal rate of +6.75%. And Nifty stumbled almost -100 points from the earlier session high.

Overall, Nifty lost -1.40% for November (till 11^th) on mixed global/U.S. cues and more hawkish than expected RBI policy action. The Indian market was also buoyed by upbeat real GDP for Q2FY23, showing yearly growth of +6.35% and sequential +3.58% (against -9.64% sequential in Q1FY23). Also, India’s Composite PMI came better than expected. Banks got some boost on the extension of enhanced HTM limit for SLR holdings from Mar’23 to Mar’24. But looking ahead, persistently higher borrowing costs may affect the affordability/eligibility of borrowers and subsequently credit growth; NPA may rise, resulting in higher credit costs and lower profitability.

Nifty jumped almost +4% in November –boosted by banks & financials, metals, techs/ITs, media, realty, infra, FMCG, and energy, while dragged by pharma and auto. RIL helped lower the windfall tax policy by the government. Indian stock market was also boosted by MSCI rejig inflow boost for around Rs.47.35B (rebalancing). Tube Investment, Indian Hotels, Varun Beverages, TVS Motor, Bajaj Holdings, and ABB India were among the stocks that were included in MSCI Global Standard Index; Zomato saw an increase in weight.

Meanwhile, 20 stocks saw a reduction in their weight in the index that included Infosys, ICICI Bank, HDFC, TCS, HCL Tech, SBI, ITC, Maruti Suzuki, and Kotak Mahindra Bank. With a huge last-day investment (mostly related to MSCI inflow), the total FII investment during November rose to Rs 225.46B, helping Dalal Street to scale a new lifetime high. While FIIs were busy buying, DIIs sold almost Rs.6.30B in November. The Indian market was also undercut as several key blue chips undergo a reduction in their weight in the MSCI index.

Highlights of RBI monetary policy: 7^th December’2022

·         Hikes all effective policy rates by +0.35% to Repo rate +6.25%; Reverse Repo (SDF) rate by +6.00%; MSF and Bank rate by +6.50%

·         Forward guidance: Continues to hike in a smaller/calibrated manner to ensure inflation remains  within the target while supporting economic growth

·         Economic projection: Inflation (CPI): +6.7% (FY23); +6.5% (Q3FY23); +5.8% (Q4FY23); +5.0% (Q1FY24)

·         Real GDP growth: +6.8% vs prior +7.0% (FY23); +7.2% (Q1FY24)

·         Quite concerned about sticky core inflation around +6.0%

·         Quite upbeat about the resilient/robust Indian economy despite global macro headwinds (economic fragility)

·         Apart from inflation management, calibrated rate hikes are also required to match Fed hikes and currency stability/differential; a rapidly depreciated currency will cause more imported inflation

·         Will continue to keep ‘Arjuna’s eye’ on the evolving inflation dynamics

·         India has a stable macroeconomy and financial system

·         India is a bright spot in a gloomy world

·         Although most of the reasons for elevated inflation are supply-side global issues, domestic demand for services is also elevated after COVID and due to festival season; thus RBI is going for calibrated tightening to control inflation expectations and actual inflation to become enriched

·         India’s growth momentum will be supported by robust government and private consumption & capex (infra spending) along with booming service and increasing merchandise export despite adverse global macro headwinds

·         RBI is now giving priority to managing inflation as it’s substantially higher than the target, while economic growth is still robust

·         Overall system liquidity is still surplus and RBI will continue to maintain adequate liquidity through both absorption and injection as par evolving situation

·         RBI will continue to maintain orderly movement (volatility) policy in USDINR (through measured intervention and calibrated policy)

·         RBI expects that US Fed will soon reach its primary terminal rate and give a pause in ongoing back-to-back rate hikes

·         India’s CAD is manageable (despite elevated) if we consider total merchandise and service export along with robust remittances flow

·         India’s external debt ratios are quite smaller by international standards; i.e. foreign currency debt is not significantly high

·         The ratio of reserves to total external debt has increased to 95.5% in June’22 from 71.3% in FY13.

·         The external debt service ratio (principal repayments and interest payments as a ratio of current earnings) at 4.9% in June’22 was lower than 5.9% in FY13; Currently, it is one of the lowest among emerging market peers

·         Indian currency (INR) is quite stable and outperforms compared to many other EM and AE currencies

·         The course of our future policy will duly consider new data releases and the evolving outlook of the economy as well as the effect of past policy actions

·         Looking ahead, the Indian economy will be benefited from the green transition, global reconfiguration of supply chains and logistics, production-linked incentive schemes (PLI), make-in-India thrust, digital banking & financial services (digital evolution), and innovative technologies (innovation)

·         RBI will be data-dependent and nimble in future policy actions

·         The policy repo rate at +6.25% is still accommodative as the headline CPI rate was around +6.75% in October

Monetary Policy Statement, 2022-23 Resolution of the Monetary Policy Committee (MPC) December 5-7, 2022

On the basis of an assessment of the current and evolving macroeconomic situation, the Monetary Policy Committee (MPC) at its meeting today (December 7, 2022) decided to:

Increase the policy repo rate under the liquidity adjustment facility (LAF) by 35 basis points to 6.25 percent with immediate effect. Consequently, the standing deposit facility (SDF) rate stands adjusted to 6.00 percent and the marginal standing facility (MSF) rate and the Bank Rate to 6.50 percent. The MPC also decided to remain focused on the withdrawal of accommodation to ensure that inflation remains within the target going forward while supporting growth. These decisions are in consonance with the objective of achieving the medium-term target for consumer price index (CPI) inflation of 4 percent within a band of +/- 2 percent while supporting growth.

The main considerations underlying the decision are set out in the statement below.

Assessment

Global Economy

The global economic outlook is skewed to the downside. Global growth is set to lose momentum as monetary policy actions tighten financial conditions and as consumer confidence weakens with the rising cost of livelihood. Inflation remains elevated and persistent across countries as they grapple with food and energy price shocks and shortages. More recently, however, there are some signs of moderation in price pressures, which have raised expectations of an easing in the pace of monetary tightening. Alongside easing in sovereign bond yields, the US dollar has come off its highs. Capital flows to emerging market economies (EMEs) remain volatile and global spillovers pose risks to growth prospects.

Domestic Economy

On the domestic front, real gross domestic product (GDP) increased by 6.3 percent year-on-year (y-o-y) in Q2 2022-23 after an increase of 13.5 percent in Q1. On the supply side, gross value added (GVA) rose by 5.6 percent in Q2.

In Q3, economic activity is exhibiting resilience. In the agricultural sector, a pick-up in rabi sowing (6.4 percent higher than a year ago on December 2) is supported by the good progress of the northeast monsoon and above-average reservoir levels. Activity in the industry and services sectors is in expansion mode, as reflected in purchasing managers’ indices (PMIs) and other high-frequency indicators.

Aggregate demand conditions have been supported by pent-up spending and discretionary expenditures during the festival season, although their evolution is somewhat uneven across sectors. Urban demand has remained buoyant, and rural demand is recovering. Investment activity is in modest expansion. Merchandise exports contracted in October after an expansion for 19 consecutive months. Growth in non-oil non-gold imports decelerated.

CPI inflation moderated to 6.8 percent (y-o-y) in October 2022 from 7.4 percent in September, with favorable base effects mitigating the impact of a pick-up in price momentum in October. Food inflation softened, aided by easing inflation in vegetables and edible oils, despite sustained pressures from prices of cereals, milk, and spices. Fuel inflation registered some easing in October, driven by softening of price inflation in LPG, kerosene (PDS), and firewood and chips. Core CPI (i.e., CPI excluding food and fuel) inflation persisted at elevated levels at 6 percent, with price pressures across most of its constituent sub-groups.

The overall liquidity remains in surplus, with average daily absorption under the liquidity adjustment facility (LAF) at ₹1.4 lakh crore during October-November as compared with ₹2.2 lakh crore in August-September. On a y-o-y basis, money supply (M3) expanded by 8.9 percent as on November 18, 2022, while bank credit rose by 17.2 percent. India’s foreign exchange reserves were placed at US$ 561.2 billion as on December 2, 2022.

Outlook

The inflation trajectory going ahead would be shaped by both global and domestic factors. In the case of food, while vegetable prices are likely to see seasonal winter correction, prices of cereals and spices may stay elevated in the near term on supply concerns. High feed costs could also keep inflation elevated in respect of milk. Adverse climate events – both domestic and global – are increasingly becoming a significant source of upside risk to food prices.

Global demand is weakening. In baiting geopolitical tensions continue to impart uncertainty to the food and energy prices outlook. The correction in industrial input prices and supply chain pressures, if sustained, could help ease pressures on output prices; but the pending pass-through of input costs could keep core inflation firm. Imported inflation risks from the US dollar movements need to be watched closely.

Taking into account these factors and assuming an average crude oil price (Indian basket) of US$ 100 per barrel, inflation is projected at 6.7 percent in 2022-23, with Q3 at 6.6 percent and Q4 at 5.9 percent, and risks evenly balanced. CPI inflation for Q1:2023-24 is projected at 5.0 percent and for Q2 at 5.4 percent, on the assumption of a normal monsoon.

On growth, the agricultural outlook has brightened, with the prospects of a good Rabi harvest. The sustained rebound in contact-intensive sectors is supporting urban consumption. Robust and broad-based credit growth and the government’s thrust on capital spending and infrastructure should bolster investment activity. According to the RBI’s survey, consumer confidence is improving. The economy, however, faces accentuated headwinds from protracted geopolitical tensions, tightening global financial conditions, and slowing external demand.

Taking all these factors into consideration, the real GDP growth for 2022-23 is projected at 6.8 percent with Q3 at 4.4 percent and Q4 at 4.2 percent, with risks evenly balanced. Real GDP growth is projected at 7.1 percent for Q1 2023-24 and 5.9 percent for Q2.

Inflation has ruled at or above the upper tolerance band since January 2022 and core inflation is persisting at around 6 percent. Headline inflation is expected to remain above or close to the upper threshold in Q3 and Q4:2022-23. It is likely to moderate in H1:2023-24 but will remain well above the target.

Meanwhile, economic activity has held up well and is expected to be resilient, supported by domestic demand. Net exports would remain subdued due to the drag from evolving external demand conditions. Further, the impact of monetary policy measures undertaken needs to be watched.

On balance, the MPC is of the view that further calibrated monetary policy action is warranted to keep inflation expectations anchored, break the core inflation persistence, and contain second-round effects, so as to strengthen medium-term growth prospects. Accordingly, the MPC decided to increase the policy repo rate by 35 basis points to 6.25 percent. The MPC also decided to remain focused on the withdrawal of accommodation to ensure that inflation remains within the target going forward while supporting growth.

Dr. Shashanka Bhide, Dr. Ashima Goyal, Dr. Rajiv Ranjan, Dr. Michael Debabrata Patra, and Shri Shaktikanta Das voted to increase the policy repo rate by 35 basis points. Prof. Jayanth R. Varma voted against the repo rate hike.

Dr. Shashanka Bhide, Dr. Rajiv Ranjan, Dr. Michael Debabrata Patra, and Shri Shaktikanta Das voted to remain focused on the withdrawal of accommodation to ensure that inflation remains within the target going forward while supporting growth. Dr. Ashima Goyal and Prof. Jayanth R. Varma voted against this part of the resolution.

The minutes of the MPC’s meeting will be published on December 21, 2022.

The next meeting of the MPC is scheduled during February 6-8, 2023.

RBI Governors’ Statement: December 7, 2022

As we come to the end of yet another turbulent year, the global economy is still marred by profound shocks and unprecedented uncertainty. Mixed signals are emanating from the geopolitical situation and financial market volatility. In the beginning of this year (2022), just as the COVID-19 pandemic was receding, the war in Ukraine overwhelmed the world in a black swan moment and fundamentally altered the global economic outlook.

Surges in food and energy prices and shortages in key staples have severely affected the poorer sections across the world. Though international food, energy, and other commodity prices have eased moderately in recent times, inflation remains high and broad-based. The IMF has projected that more than one-third of the global economy will contract this year or next year. While no country is spared the ill effects of such large shocks, emerging market economies (EMEs), especially the ones dependent on food, energy and commodity imports, have been the worst affected.

Looking beyond the pandemic and the war, fragmentation in trade, finance, and technology is also adding to the forces of delocalization. Supply chains are being redrawn on considerations of geopolitical security, leading to ‘reshoring’ and ‘friend-shoring’. Food and energy security, together with climate change, has become the biggest challenge to the world.

In this hostile international environment, the Indian economy remains resilient, drawing strength from its macroeconomic fundamentals. Our financial system remains robust and stable. Banks and corporates are healthier than before the crisis. Bank credit is growing in double digits for 8 months now. India is widely seen as a bright spot in an otherwise gloomy world. Yet, our inflation remains elevated, as in most parts of the world. Global spillovers continue to impart high volatility and uncertainty.

Decisions and Deliberations of the Monetary Policy Committee (MPC)

The Monetary Policy Committee (MPC) met on the 5th, 6th, and 7th of December 2022. Based on an assessment of the macroeconomic situation and its outlook, the MPC decided by a majority of 5 members out of 6 to increase the policy repo rate by 35 basis points to 6.25 percent with immediate effect. Consequently, the standing deposit facility (SDF) rate stands adjusted to 6.00 percent, and the marginal standing facility (MSF) rate and the Bank Rate to 6.50 percent. The MPC also decided by a majority of 4 out of 6 members to remain focused on the withdrawal of accommodation to ensure that inflation remains within the target going forward while supporting growth.

Let me now elaborate on the MPC’s rationale behind these decisions on the policy rate and the stance. Growth prospects across the world are dampening. Financial markets remain nervous and are characterized by high volatility and price swings.

For the Indian economy, the outlook is supported by good progress of Rabi sowing, sustained urban demand, improving rural demand, a pick-up in manufacturing, a rebound in services, and robust credit expansion. Consumer price inflation moderated to 6.8 percent (y-o-y) in October as expected, but it still remains above the upper tolerance band of the target. Core inflation is exhibiting stickiness. While headline inflation may ease through the rest of the year and Q1:2023-24, it is expected to rule above the target. The medium-term inflation outlook is exposed to heightened uncertainties from geopolitical tensions, financial market volatility, and the rising incidence of weather-related disruptions.

On balance, the MPC was of the view that further calibrated monetary policy action is warranted to keep inflation expectations anchored, break core inflation persistence and contain second-round effects. These actions will strengthen the medium-term growth prospects of the Indian economy. Accordingly, the MPC decided to increase the policy repo rate by 35 basis points to 6.25 percent and to remain focused on the withdrawal of accommodation, while supporting growth.

As regards the stance of monetary policy, the MPC took a holistic view of the policy rate and liquidity conditions relative to inflation. Adjusted for inflation, the policy rate still remains accommodative. Over the next 12 months, inflation is expected to remain higher than the 4 percent target. System liquidity remains in surplus with an average daily absorption under the liquidity adjustment facility (LAF) of ₹1.6 lakh crore in November 2022. Since then, it has gone up to ₹2.6 lakh crore as of 5th December. The overall monetary and liquidity conditions remain accommodative and hence, the MPC decided to remain focused on the withdrawal of accommodation.

Assessment of Growth and Inflation Growth

According to the latest data released by National Statistical Office (NSO), real gross domestic product (GDP) posted a growth of 6.3 percent year-on-year (y-o-y) in Q2:2022-23, driven primarily by private consumption and investment. This is in line with our expectations.

Going into Q3:2022-23; economic activity continued to gain strength in October. Urban consumption firmed up further, driven by a sustained recovery in discretionary spending, especially on services such as travel, tourism, and hospitality. Passenger vehicle sales and domestic air passenger traffic posted robust y-o-y growth. Rural demand is recovering as reflected in the pace of tractor and retail two-wheeler sales, with rising farm activity. Investment activity is also gaining traction.

Non-food bank credit rose by ₹10.6 lakh crore during April-November 2022 as compared with an increase of ₹1.9 lakh crore last year. The total flow of resources to the commercial sector expanded by ₹14.7 lakh crore during 2022-23 (up to November 2022) as compared with ₹6.8 lakh crore in the same period of 2021-22.

On the other hand, the drag from net external demand was further accentuated in October as merchandise exports contracted by 12.1 percent (y-o-y) after expanding during the previous 19 months. Merchandise imports expanded by 10.0 percent in October.

On the supply side, the agricultural sector remains resilient. Rabi sowing got off to a strong start. The area sown so far is 6.8 percent higher than the normal sown area (as on December 2, 2022). The manufacturing PMI rose from 55.3 in October to 55.7 in November. The PMI for the services sector expanded from 55.1 in October to 56.4 in November. Incidentally, the manufacturing and services PMIs for India in November are among the highest in the world. Construction activity is picking up after the end of the southwest monsoon, as indicated by the high growth of steel consumption in October.

Going ahead, investment activity will get support from government capex. A pick-up in the share of fixed assets in the total assets of manufacturing companies was visible in H1. According to our surveys, consumer confidence has improved further. Manufacturing and infrastructure sector firms are optimistic about the business outlook. Services sector firms also expect activity to expand. In an interconnected world, we cannot remain entirely decoupled from adverse spillovers from the global slowdown and its negative impact on our net exports and overall economic activity. The biggest risks to the outlook continue to be the headwinds emanating from protracted geopolitical tensions, global slowdown, and tightening of global financial conditions.

Taking all these factors into consideration, real GDP growth for 2022-23 is projected at 6.8 percent, with Q3 at 4.4 percent and Q4 at 4.2 percent. The risks are evenly balanced. Real GDP growth is projected at 7.1 percent for Q1 2023-24 and at 5.9 percent for Q2. Even after this revision in our growth projection for 2022-23, India will still be among the fastest-growing major economies in the world.

Inflation

The inflation trajectory has largely evolved in line with the outlook given by us in June 2022. Going forward, food inflation is likely to moderate with the usual winter softening and the likelihood of a bountiful Rabi harvest, but pressure points remain in the form of prices of cereals, milk, and spices in the near term. The main risk is that core inflation (CPI excluding food and fuel) remains sticky and elevated. Overall, the CPI price momentum remains high. Risks from adverse weather events add to uncertainty in the outlook.

Global commodity prices, including crude oil, have undergone some downward correction, but uncertainty continues to surround the near-term outlook in view of the prolonging geo-political hostilities. The outlook for the US dollar and hence imported inflation also remains uncertain. Moreover, the resurgence in domestic services sector activity could also lead to price increases, especially as firms pass on input costs.

Taking into account these factors and assuming an average crude oil price (Indian basket) of US$ 100 per barrel, headline inflation is projected at 6.7 percent in 2022-23, with Q3 at 6.6 percent and Q4 at 5.9 percent. The risks are evenly balanced. CPI inflation for Q1:2023-24 is projected at 5.0 percent and for Q2 at 5.4 percent, on the assumption of a normal monsoon.

What do these growth and inflation scenarios convey? Let me summarize. GDP growth in India remains resilient and inflation is expected to moderate, but the battle against inflation is not over. Pressure points from high and sticky core inflation and exposure of food inflation to international factors and weather-related events do remain. While being watchful of the impact of our earlier monetary policy actions, we will keep Arjuna’s eye3 on the evolving inflation dynamics and be ready to act as may be necessary. Our actions will be nimble and in the best interest of the economy. The aspect of growth will obviously be kept in mind.

Liquidity and Financial Market Conditions

Overall system liquidity remains in surplus. During October-November, the average total absorption under the liquidity adjustment facility (LAF) was ₹1.4 lakh crore, down from the average of ₹2.2 lakh crore during August-September.

In the period ahead, liquidity conditions are likely to improve due to several factors which would include moderation in currency in circulation in the post-festival period, a pick up in government expenditure in the last few months of the financial year, and higher forex inflows due to the return of portfolio investors. Tax outflows and currency demand do produce transient episodes of tight liquidity, but a holistic view needs to be taken. I reiterate that the Reserve Bank remains nimble and flexible in its liquidity management operations to meet the requirements of the productive sectors of the economy.

Therefore, although the Reserve Bank remains in absorption mode, we are ready to conduct LAF operations that inject liquidity as may be needed through our main operations. In doing so, however, we will look for a durable sign of a turn in the liquidity cycle when banks draw down a large part of their standing deposit facility (SDF) and variable rate reverse repo (VRRR) balances. The Reserve Bank remains committed to flexibility and two-sidedness in liquidity operations, but market participants must wean themselves away from the overhang of liquidity surpluses.

As part of our gradual move towards normal liquidity operations, we have decided to restore market hours - from 9.00 am to 5.00 pm - in respect of call/notice/term money, commercial paper, certificates of deposit, and repo in corporate bond segments of the money market as well as for rupee interest rate derivatives.

The pace of transmission of monetary policy actions to lending and deposit rates has quickened in the current tightening phase, beginning May 2022. The weighted average lending rates (WALRs) on fresh and outstanding rupee loans have increased by 117 bps and 63 bps, respectively, during the period of May to October 2022. On the deposit side, the weighted average domestic term deposit rate on fresh and outstanding deposits increased by 150 bps and 46 bps, respectively, during the same period. We are keeping a close watch on this process of transmission.

The appreciation of the US dollar this year, which precipitated large-scale depreciation of all major global currencies including the Indian rupee (INR), has drawn wide attention. It is important to make an objective assessment of the movement of the INR in the context of global and domestic macroeconomic and financial market developments. Through this episode of US dollar appreciation, the INR’s movements have been the least disruptive, relative to peers.

In fact, the INR has appreciated against all other major currencies except a few. Cross-country comparisons of exchange rate movements are often made on an inflation-adjusted basis or what is called in real effective terms. On a financial year basis (i.e., from April 2022 to October 2022), the INR has appreciated by 3.2 percent in real terms, even as several major currencies have depreciated. The story of the INR has been one of India’s resilience and stability.

As stated by me in a recent speech6, the terminal interest rate for the US Fed is anybody’s guess, but it cannot be the case that their monetary policy will be tightened endlessly. When the tightening is over, the tide will surely turn. Capital flows to India will improve and external financing conditions will ease. In this complex world with both push and pull factors at play, the INR - which is market-determined - should be allowed to find its level and that is what we have been striving to ensure. We must deal with the current global hurricane with confidence and endurance.

External Sector

The external sector has been affected by strong global headwinds. Slowing global demand is weighing on our merchandise exports. The growth of merchandise imports is also decelerating. At the same time, the impact of the terms of trade shock due to the war in Ukraine is getting gradually normalized. It is also important to take cognizance of India’s innate buffers. The growth of services exports, mainly contributed by software, business, and travel services remained robust at 29.1 percent in April-October 2022.

Remittances are scaling new heights and the outlook is optimistic with a pick-up in activity in the middle east. According to the latest update of the World Bank, India’s remittances are estimated to grow by around 12 percent to US$ 100 billion in 2022 from US$ 89.4 billion in 2021. In Q1:2022-23, remittances to India rose by 22.6 percent year-on-year. The net balance under services and remittances remains in large surplus, partly offsetting the trade deficit. Consequently, even if the current account deficit is higher than 2021-22, it is eminently manageable and within the parameters of viability.

On the financing side, net foreign direct investment (FDI) flows have remained robust and rose to US $ 22.7 billion during April-October 2022 from US$ 21.3 billion in the corresponding period last year. Foreign portfolio flows have resumed in recent months and were positive at US$ 11.8 billion from July to 5th December 2022, led by equity flows. As a result of the measures announced by the RBI on July 6, 2022, to enhance forex inflows, new external commercial borrowing (ECB) agreements have been concluded for US$ 8.6 billion. This includes US$ 5.1 billion which exceeds the earlier threshold of US$ 750 million under the automatic route. The size of forex reserves is comfortable and has also increased. It has gone up from US$ 524.5 billion on October 21, 2022, to US$ 561.2 billion as on December 2, 2022, covering around nine months of projected imports for 2022-23. Further, India’s external debt ratios are low by international standards.

Additional Measures

I shall now announce certain additional measures.

SLR Holdings in Held to Maturity (HTM) category

To provide further flexibility to banks in managing their investment portfolios, it has been decided to extend the dispensation of an enhanced HTM limit of 23 percent up to March 31, 2024. Banks will now be allowed to include securities acquired between September 1, 2020, and March 31, 2024, in the enhanced HTM limit. The HTM limits would be restored from 23 percent to 19.5 percent in a phased manner starting from the quarter ending June 30, 2024.

Enhancing the Mandates of Unified Payments Interface (UPI)

The UPI has emerged as the most popular retail payment system in India. It currently includes functionality to process payment mandates for recurring as well as single-block-and-single-debit transactions. The capabilities of UPI will be further enhanced by introducing single-block-and-multiple-debits functionality. This facility will enable a customer to block funds in his/her account for specific purposes, which can be debited whenever needed. This will significantly enhance the ease of making payments for investments in securities including through the Retail Direct platform as well as e-commerce transactions.

Expanding the Scope of the Bharat Bill Payment System (BBPS)

The BBPS has been steadily expanding since its launch in 2017. At present, it handles recurring bill payments for merchants and utilities and does not cater to non-recurring bills. It also does not cater to bill payments or collections such as payment of fees for professional services, education fees, tax payments, rent collections, etc. for individuals even if those are recurring in nature. Therefore, the scope of BBPS is being enhanced to include all categories of payments and collections, both recurring and non-recurring, and for all categories of billers (businesses and individuals). This will make the BBPS platform accessible to a wider set of individuals and businesses who can benefit from the transparent payments experience, faster access to funds and improved efficiency.

Hedging of Gold in the International Financial Services Centre (IFSC)

Resident entities in India are currently not permitted to hedge their exposure to gold price risk in overseas markets. With a view to providing greater flexibility to these entities to hedge the price risk of their gold exposures, resident entities will now be permitted to hedge their gold price risk on recognized exchanges in the IFSC. This measure will benefit importers/exporters of gold such as jewelers and industries which use gold as an intermediate or raw material.

Conclusion

The last three years have been unusually challenging as we encountered multiple shocks. The buffers we built in the years leading to COVID-19 in terms of accumulating reserves and inflation averaging close to the target came good to deal with these repeated shocks. In this arduous period, our constant endeavor has been to take timely and effective measures. It is gratifying to see that our policies have yielded positive results. The course of our future policy will duly consider new data releases and the evolving outlook of the economy as well as the effect of our past actions.

In meeting the challenges thrust upon us by a hostile global environment, we should not lose sight of the task of improving the long-term potential of our country. Green transition, reconfiguration of supply chains and logistics, production-linked incentive schemes, digital banking, and financial services, and innovative technologies offer immense opportunities for the Indian economy.

As we enter 2023, India’s G20 presidency provides us a historic opportunity to play a bigger role in the international arena. The theme of our Presidency “Vasudhaiva Kutumbakam” – the world is one family – reflects our vision of global cooperation for universal welfare. We must remain optimistic and derive inspiration from the words of Gandhiji: “Let no one think that it is impossible because it is difficult. It is the highest goal, and it is no wonder that the highest effort should be necessary to attain it.” As the current year ends and a new one awaits, I wish you all a happy new year in advance.

Conclusions:

Fed is now preparing the market for a real positive rate, at least wrt average core inflation (CPI/PCE) of +5.50%. Fed is now preparing the market for smaller rates of increases, but higher for longer. Fed will now focus on an appropriate terminal rate, restrictive enough (real positive) to bring down inflation towards the +2% target over the medium term. When the cost of borrowing turns real positive or there is an elevated cost of capital, overall economic activity/demand bounds to slow down, leading to lower inflation (as lower demand will try to catch up with the constrained supply capacity of the economy). Also, a real positive rate would encourage savings than spending, negative for discretionary spending and inflation.

The market is now expecting Fed will hike +50 bps on 14^th December to +4.50% and a further 50-100 bps by Mar’23 to 5.00-5.50% (depending upon the actual core inflation trajectory). Fed is now preparing the market for a possible series of smaller hikes (50 bps) and pauses down the road after reaching around +5.50%. But Fed is also confused about levels of an appropriate terminal rate and may start the debate in the December meeting to take a firm decision with a fresh SEP. Fed may go from meeting-to-meeting to a QTR-to-QTR approach in 2023 after Q1 ( if required further hikes).

Fed may keep the terminal rate around +5.50% for at least 2023 to bring down core PCE inflation back to +2.00% on a sustainable basis. As the U.S. labor market and inflation are still substantially hot despite some signs of cooling, Fed will continue to hike at a slower pace at +50 bps in December, February, and March for a terminal rate of +5.50% by Q1CY23. Fed may also cut rates from early 2024 and even launch QE-5 if U.S. inflation falls below +2.00% by Dec’23, while unemployment levels surged above 5.00-5.50%.

Now from Wall Street to Dalal Street, India’s RBI may also hike +0.25% on 8^th February and further +0.25% in April’23 for a terminal rate of +6.75% against the Fed’s +5.50%. India’s core CPI continues to be sticky around +6.00% and thus RBI wants to ensure a real positive rate, wrt at least core inflation.

Thus RBI will continue to tighten to keep interest rate/bond yield differential and also USDINR under control, which will also control imported inflation and manage overall price stability. RBI has to tighten in a calibrated way to bring inflation down by curtailing demand; i.e. slowing down the economy to some extent without causing an all-out recession for a safe and soft landing.

As per Taylor’s rule, for India:

Recommended policy rate (I) = A+B+(C+D)*(E-B) =0.50+4+ (1.5+0)*(6-4) =0+4+1.5*2=0.50+4+3=7.50%

Here for RBI/India:

A=desired real interest rate=0.50; B= inflation target =4; C= permissible factor from deviation of inflation target=1.5 (6/4); D= permissible factor from deviation of output target from potential=0; E= average core CPI=6

If Fed continues to hike even after Mar’23 (in case core inflation surges more), then RBI also has to hike (under still elevated/sticky core inflation). Thus RBI may like to keep the repo rate at +6.50/6.75% to +7.50% in FY24, depending upon the Fed rate action; as USD is the reserve/global currency, every major Central Bank has to follow Fed action to maintain bond yield/currency and policy differential (whatever may be the narrative).

As per Taylor’s rule, for the US:

Recommended policy rate (I) = A+B+(C+D)*(E-B) =0.00+2.00+ (0+0)*(5.5-2.00) =0+2+3.5=5.5%

Here for U.S. /Fed

A=desired real interest rate=0.00; B= inflation target =2.00; C= permissible factor from deviation of inflation target=0; D= permissible factor from deviation of output target from potential=0.00; E= average core inflation=5.5% (average of core PCE and CPI)

Looking ahead, whatever may be the narrative, technically Nifty Future now has to sustain over 18850-900 for a further rally towards 19150; otherwise sustaining below 18800-600, Nifty Future may again fall to 17800/600-500/400-150 and lower levels in the coming days.

 

 

 

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