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RBI goes for another hawkish hold in August

Nifty was undercut by an unexpected hike in additional CRR; RBI is now keenly watching the core inflation trajectory and adapting higher for longer stance

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On Thursday (10^th August), the focus of Dalal Street was on the RBI policy meeting (MPC) outcome. As highly expected, RBI holds all its key policy rates. RBI kept the benchmark policy repo rate at +6.50%, effective reverse repo rate (SDF) at +6.25%, MSF (Marginal Standing Facility), and Bank rate at +6.75%.

But RBI unexpectedly imposed a new CRR (Cash Reserve Ratio), called I-CRR (Incremental Cash Reserve Ratio) @10% on the increase of NDTL (Net Demand and Liabilities—mainly customer deposits) between 19/05/23 to 28/07/23 to absorb excess banking liquidity as a result of return of 2000/- notes and some other factors. This temporary I-CRR is effective from 12/08/23 and will be reviewed again on the 8^th of September of the Festival season to ensure adequate banking liquidity for the productive sector of the economy. The existing CRR remains unchanged at 4.5%.

Also, the overall stance of the RBI may be termed as hawkish hold as RBI Governor Das clarified again the present mode as a ‘pause’, not a ‘pivot’; i.e. RBI may go for further hikes in the coming months depending on the actual domestic inflation trajectory and Fed action. Das also expressed caution as India’s core inflation remains substantially above the +4.00% target, while food inflation skyrocketed in recent times.

The market was expecting an indication of rate cuts by the RBI in late 2023, but RBI didn’t provide any such forward guidance. As a result, the market is now expecting some rate cuts after FY24 rather than late 2023. Subsequently, Nifty stumbled to some extent after the RBI presser/Q&A, as Governor Das clarified that the policy action must be seen as a temporary pause, not a pivot. RBI chose to hold the repo rate for 3^rd consecutive time at +6.50% after raising +250 bps in the last FY23 to assess the impact of a cumulative hike on the real economy. RBI repo rate is now at Jan’19 levels after 6^th consecutive hike from May’22 to Apr’23.

On 10^th August, RBI maintained India’s real GDP growth estimate for the FY24 at 6.5% while raising its inflation (CPI) forecast to 5.4% from 5.1%. India’s headline inflation (CPI) sharply jumped to +7.44% in July from +4.87% in June, the highest since April ’22, and significantly higher than market expectations of +6.4% amid surging food and increasing fuel inflation. July marks the first month since March- inflation stays above the upper limit (+6.00%) of the RBI target, as irregular monsoon patterns across the country led to a spike in food prices along with elevated logistic costs and regional/rural elections in some states (political donation by local business). Previously, India’s total CPI eased to +4.3% in May’23, at its lowest since late 2022. In July, India’s total CPI jumped +2.87% sequentially (m/m).

But India’s core CPI eased to +4.90% in July from +5.10% in June and remains around +5.0% in 2023 against +6.0% on an average in 2022. The 3M rolling average of underlying total CPI may be now running around +9.90%, while the 2023 (YTD) average is now around +5.7% against +6.7% in 2022.

Full text of RBI statement: 10^th August’2023

On the basis of an assessment of the current and evolving macroeconomic situation, the Monetary Policy Committee (MPC) at its meeting today (August 10, 2023) decided to: Keep the policy repo rate under the liquidity adjustment facility (LAF) unchanged at 6.50 percent. The standing deposit facility (SDF) rate remains unchanged at 6.25 percent and the marginal standing facility (MSF) rate and the Bank Rate at 6.75 percent.

The MPC also decided to remain focused on the withdrawal of accommodation to ensure that inflation progressively aligns with the target, 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 economy is slowing and growth trajectories are diverging across regions amidst moderating but above-target inflation, tight financial conditions, simmering geopolitical conflicts, and geo-economic fragmentation. Sovereign bond yields have hardened. The US dollar fell to a 15-month low in mid-July on expectations of an early end to the monetary tightening cycle, although it recouped some of the losses subsequently. Equity markets have gained on expectations of a soft landing for the global economy. For several emerging market economies, weak external demand, elevated debt levels and tight external funding conditions pose risks to their growth prospects.

Domestic Economy

Domestic economic activity is maintaining resilience. The cumulative southwest monsoon rainfall was the same as the long period average up to August 9, 2023, although the temporal and spatial distribution has been uneven. The total area sown under kharif crops was 0.4 percent higher than a year ago as of August 4, 2023. The index of industrial production (IIP) expanded by 5.2 percent in May while core industries output rose by 8.2 percent in June. Amongst high-frequency indicators, e-way bills and toll collections expanded robustly in June-July, while rail freight and port traffic recovered in July after remaining muted in June. The composite purchasing managers’ index (PMI) rose to a 13-year high in July.

Urban demand remains robust, with domestic air passenger traffic and household credit exhibiting sustained double-digit growth. The growth in passenger vehicle sales has, however, moderated. In the case of rural demand, tractor sales improved in June while two-wheeler sales moderated. Cement production and steel consumption recorded robust growth. Import and production of capital goods continued in expansion mode. Merchandise exports and non-oil non-gold imports remained in contraction territory in June. Services exports posted subdued growth amidst slowing external demand.

Headline CPI inflation picked up from 4.3 percent in May to 4.8 percent in June, driven largely by food group dynamics on the back of higher prices of vegetables, eggs, meat, fish, cereals, pulses and spices. Fuel inflation softened during May-June, primarily reflecting the fall in kerosene prices. Core inflation (i.e., CPI excluding food and fuel) was steady in June.

The daily absorption of liquidity under the LAF averaged ₹1.8 lakh crore during June-July as compared with ₹1.7 lakh crore in April-May. Money supply (M3) expanded by 10.6 percent y-o-y as of July 28, 2023, as against 10.1 percent on May 19, 2023. Bank credit grew by 14.7 percent y-o-y as of July 28, 2023, as compared with 15.4 percent on May 19, 2023. India’s foreign exchange reserves stood at US$ 601.5 billion as of August 4, 2023.

Outlook

Going forward, the spike in vegetable prices, led by tomatoes, would exert sizeable upside pressures on the near-term headline inflation trajectory. This jump is, however, likely to correct with fresh market arrivals. There has been significant improvement in the progress of the monsoon and kharif sowing in July; however, the impact of the uneven rainfall distribution warrants careful monitoring. Crude oil prices have firmed up amidst production cuts. Manufacturing, services, and infrastructure firms polled in the Reserve Bank’s enterprise surveys expect input costs to ease but output prices to harden.

Taking into account these factors and assuming a normal monsoon, CPI inflation is projected at 5.4 percent for 2023-24, with Q2 at 6.2 percent, Q3 at 5.7 percent and Q4 at 5.2 percent, with risks evenly balanced. CPI inflation for Q1:2024-25 is projected at 5.2 per cent.

Looking ahead, the recovery in kharif sowing and rural incomes, the buoyancy in services, and consumer optimism should support household consumption. Healthy balance sheets of banks and corporates, supply chain normalization, business optimism and robust government capital expenditure are favorable for a renewal of the capex cycle which is showing signs of getting broad-based. Headwinds from weak global demand, volatility in global financial markets, geopolitical tensions and geo-economic fragmentation, however, pose risks to the outlook.

Taking all these factors into consideration, real GDP growth for 2023-24 is projected at 6.5 percent with Q1 at 8.0 percent; Q2 at 6.5 percent; Q3 at 6.0 percent; and Q4 at 5.7 percent, with risks broadly balanced. Real GDP growth for Q1:2024-25 is projected at 6.6 per cent.

The headline inflation is likely to witness a spike in the near months on account of supply disruptions due to adverse weather conditions. It is important to be vigilant about these shocks with a readiness to act appropriately to ensure that their effects on the general level of prices do not persist. There are risks from the impact of the skewed south-west monsoon so far, a possible El Niño event and upward pressures on global food prices due to geopolitical hostilities.

Domestic economic activity is holding up well, supported by domestic demand despite the drag from weak external demand. With the cumulative rate hike of 250 basis points undertaken by the MPC working its way into the economy, the MPC decided to keep the policy repo rate unchanged at 6.50 percent, but with preparedness to undertake policy responses, should the situation so warrant. The MPC will maintain a close vigil on the evolving inflation scenario and remain resolute in its commitment to aligning inflation to the target and anchoring inflation expectations. The MPC also decided to remain focused on the withdrawal of accommodation to ensure that inflation progressively aligns with the target, while supporting growth.

All members of the MPC – Dr. Shashanka Bhide, Dr. Ashima Goyal, Prof. Jayanth R. Varma, Dr. Rajiv Ranjan, Dr. Michael Debabrata Patra, and Shri Shaktikanta Das – unanimously voted to keep the policy repo rate unchanged at 6.50 percent.

Dr. Shashanka Bhide, Dr. Ashima Goyal, Dr. Rajiv Ranjan, Dr. Michael Debabrata Patra, and Shri Shaktikanta Das voted to remain focused on the withdrawal of accommodation to ensure that inflation progressively aligns with the target while supporting growth. Prof. Jayanth R. Varma expressed reservations on this part of the resolution.

The minutes of the MPC’s meeting will be published on August 24, 2023.

The next meeting of the MPC is scheduled for October 4-6, 2023.

Full text of RBI Governor Das’s prepared statement: 8^th June’2023

As we celebrate India’s 77th Independence Day in a few days, I am happy to note that the Indian economy is exuding enhanced strength and stability despite the massive shocks to the global economy in recent years. Our economy has continued to grow at a reasonable pace, becoming the fifth-largest economy in the world and contributing around 15 percent to global growth.

We have also made significant progress towards controlling inflation. Our banks remain healthiest in more than a decade with historically high levels of capital, declining levels of non-performing assets, and rising profitability. Corporate balance sheets are robust, with lower leverage, improving debt servicing capacity and strong profitability.

A lower current account deficit and ample capital flows have imparted strength to our external sector. The resultant accretion to forex reserves has provided a buffer against external shocks. Overall, India’s strong macroeconomic fundamentals have laid the foundations for sustainable growth.

In a moment like this, we need to continue with our efforts to maintain macro-financial stability while pushing our growth frontier further. India is uniquely placed to benefit from the ongoing transformational shifts in the global economy in the wake of geopolitical realignments and technological innovations. With a large economy marching ahead with vast domestic demand, untapped resources and demographic advantages, India can become the new growth engine for the world.

Decisions and Deliberation of the Monetary Policy Committee (MPC)

The Monetary Policy Committee (MPC) met on the 8th, 9th and 10th of August 2023. After detailed deliberation on all relevant aspects, it decided unanimously to keep the policy repo rate unchanged at 6.50 percent. Consequently, the standing deposit facility (SDF) rate remains at 6.25 percent and the marginal standing facility (MSF) rate and the Bank Rate at 6.75 percent. The MPC also decided by a majority of 5 out of 6 members to remain focused on the withdrawal of accommodation to ensure that inflation progressively aligns with the target, while supporting growth.

Let me now explain the MPC’s rationale for these decisions on the policy rate and the stance. Headline inflation, after reaching a low of 4.3 percent in May 2023, rose in June and is expected to surge during July-August led by vegetable prices. While the vegetable price shock may reverse quickly, possible El Niño weather conditions along with global food prices need to be watched closely against the backdrop of a skewed southwest monsoon so far. These developments warrant a heightened vigil on the evolving inflation trajectory.

The cumulative rate hike of 250 basis points undertaken by the MPC is working its way into the economy. Nonetheless, domestic economic activity is holding up well and is likely to retain its momentum, despite weak external demand. Considering this confluence of factors, the MPC decided to remain watchful and evaluate the emerging situation. Consequently, the MPC decided to keep the policy repo rate unchanged at 6.50 percent with the preparedness to act, should the situation warrant. The MPC remains resolute in its commitment to aligning inflation to the 4 percent target and anchoring inflation expectations.

Further, with the monetary transmission still underway and headline inflation remaining higher than the 4 per cent target, the MPC decided to remain focused on the withdrawal of accommodation to ensure that inflation progressively aligns with the target, while supporting growth.

Assessment of Growth and Inflation

Global Growth

The global economy continues to face daunting challenges of elevated inflation, high levels of debt, tight and volatile financial conditions, continuing geopolitical tensions, fragmentations, and extreme weather conditions. Belying earlier apprehensions, a number of economies have demonstrated remarkable resilience and the grim prospects of hard landing appear to have receded. Nevertheless, global growth is likely to remain low by historical standards in the current year and the next few years, despite the upward revision in the global growth forecast for 2023 by the IMF. World merchandise trade volume growth is projected by the WTO to decelerate from 2.7 percent in 2022 to 1.7 percent in 2023.

Headline inflation is easing unevenly across countries and remains above the target in major economies. While the pace of monetary tightening has been scaled down, policy rates could stay higher for longer. Financial markets, which had been buoyed by expectations of an early end to the cycle of monetary tightening, have turned volatile with sizeable two-way movements in response to recent rating events and incoming data.

Domestic Growth

These external factors are likely to impinge on the growth prospects of most major advanced and emerging economies. India is, however, expected to withstand these external headwinds far better than many other countries.

The momentum of overall economic activity in India continues to be positive. On the supply side, crop sowing has picked up with steady progress in the south-west monsoon. The temporal and spatial distribution of monsoons has, however, been uneven. Industrial activity is holding ground as is evident from the latest data on the index of industrial production (IIP), core industries output and purchasing managers’ index (PMI) for manufacturing. Buoyant services activity is reflected in healthy expansion in e-way bills, toll collections, railway freight and a sharp jump in services PMI. On the other hand, commercial vehicle sales and domestic air cargo traffic contracted during Q1: 2023-24.

Aggregate demand conditions continue to be buoyant. Among urban demand indicators, domestic air passenger traffic, passenger vehicle sales, and household credit are exhibiting sustained growth. In the case of rural demand, tractor and fertilizer sales improved in June while two-wheeler sales moderated. High growth in agricultural credit and improving sales volume of major fast-moving consumer goods (FMCG) companies suggest an incipient recovery in rural demand, which will be reinforced by improving kharif prospects.

Investment activity gained further steam on the back of government capital expenditure; rising business optimism and a revival in private capex in certain key sectors. The continued increase in import and production of capital goods further reaffirms this trend. Construction activity also remained strong in Q1 as indicated by healthy growth in cement production and steel consumption. Capacity utilization in the manufacturing sector at 76.3 percent (and 74.1 percent on a seasonally adjusted basis) remained above the long-term average of 73.7 percent.

The total flow of resources to the commercial sector from banks and other sources taken together has increased by ₹7.5 lakh crore during the financial year 2023-24 so far (up to July 28) as compared with ₹5.7 lakh crore a year ago. On the downside, merchandise exports and non-oil non-gold imports contracted further in June and the growth in services exports decelerated amidst slowing external demand.

Despite such surplus liquidity, the market response to RBI’s 14-day variable rate reverse repo (VRRR) auctions was lukewarm; instead, banks preferred to place their surplus liquidity in the less remunerative standing deposit facility (SDF). Although the fine-tuning VRRR auctions of 1-4 days maturity during this period evoked better response from the market, this essentially reflects greater risk aversion among banks to park large funds under the main operation. In this context, it is necessary to reiterate that fine-tuning operations (overnight and up to 13 days) are undertaken to deal with special or exceptional situations and cannot become the rule.

In recent years, our stated stance on liquidity is to maintain adequate liquidity in the system to meet the productive requirements of the economy. Excessive liquidity, on the other hand, can pose risks to price stability and also to financial stability. Hence, efficient liquidity management requires continuous assessment of the level of surplus liquidity so that additional measures are taken as and when necessary to impound the element of excess liquidity.

Accordingly, it has been decided that with effect from the fortnight beginning August 12, 2023, scheduled banks shall maintain an incremental cash reserve ratio (I-CRR) of 10 percent on the increase in their net demand and time liabilities (NDTL) between May 19, 2023, and July 28, 2023. This measure is intended to absorb the surplus liquidity generated by various factors referred to earlier including the return of ₹2000 notes to the banking system.

This is purely a temporary measure for managing the liquidity overhang. Even after this temporary impounding, there will be adequate liquidity in the system to meet the credit needs of the economy. The I-CRR will be reviewed on September 8, 2023, or earlier to return the impounded funds to the banking system ahead of the festival season. I must add that the existing cash reserve ratio (CRR) remains unchanged at 4.5 percent.

Financial Stability

The Indian financial sector has been stable and resilient, as reflected in sustained growth in bank credit, low levels of non-performing assets, and adequate capital and liquidity buffers. Macro stress tests for credit risk reveal that scheduled commercial banks (SCBs) would be able to comply with the minimum capital requirements even under severe stress scenarios. There is, however, no room for complacency because it is during tranquil and good times that vulnerabilities may creep in.

Hence, buffers are best built up during these periods. A stable financial system is a prerequisite for price stability and sustained growth. This is a shared responsibility in which regulated entities like banks, NBFCs, and others are important stakeholders. On its part, the Reserve Bank remains steadfast in its commitment to safeguard the financial system from emerging and potential challenges. We expect the same from the regulated entities also.

External Sector

India’s current account deficit (CAD) was contained at 2.0 percent of GDP in 2022-23 as compared with 1.2 percent in 2021-22. The merchandise trade deficit has narrowed in Q1 of 2023-24 with the contraction in imports exceeding contraction in exports. Services exports and remittances are, however, expected to provide a cushion to the current account deficit. We, therefore, expect CAD to remain eminently manageable during the current financial year also.

On the financing side, foreign portfolio investment (FPI) flows have remained buoyant in 2023-24 so far. Net FPI inflows have been US$ 20.1 billion up to August 8, 2023, which is the highest since 2014-15. In the corresponding period of the previous year, there were net outflows of US$ 12.6 billion. The inflows under external commercial borrowings also witnessed a turnaround, with net inflows of US$ 6.0 billion during April-June 2023 as against net outflows of US$ 2.9 billion a year ago.

Net foreign direct investment (FDI) flows to India, on the other hand, fell to US$ 5.5 billion during April-May 2023 from US$ 10.6 billion a year ago, reflecting a global slowdown in FDI flows. The latest available data suggest that India’s external debt to GDP ratio improved to 18.9 percent at the end of March 2023 from 20.0 percent at the end of March 2022.

The Indian rupee has remained stable since January 2023. Foreign exchange reserves have crossed the US$ 600 billion mark. The umbrella has gathered further strength, and I am not saying this in the context of the monsoon rains!

Additional Measures

I shall now announce certain additional measures.

Review of Regulatory Framework for Financial Benchmark Administrators

It has been decided to revise the extant regulations issued in June 2019 and put in place a comprehensive, risk-based framework for the administration of financial benchmarks. This will cover all benchmarks related to foreign exchange, interest rates, money markets and government securities. The revised directions will provide greater assurance about the accuracy and integrity of financial benchmarks.

Review of Regulatory Framework for Infrastructure Debt Fund - NBFCs (IDF-NBFCs)

At present, Infrastructure Debt Funds (IDFs) provide refinancing facilities for lenders in the infrastructure sector. The extant regulatory framework for IDFs has been revised. The key changes in the revised framework are (i) withdrawal of the requirement to have a sponsor for the IDFs; (ii) allowing IDFs to finance toll-operate-transfer (ToT) projects as direct lenders; (iii) permitting IDFs to raise funds through ECBs; and (iv) making tri-partite agreements optional for PPP projects. These changes are expected to further augment the capacity for infrastructure financing in the country.

Greater Transparency in Interest Rate Reset of Equated Monthly Instalments (EMI) based Floating Interest Loans

It is proposed to put in place a transparent framework for resetting interest rates on floating-interest loans. The framework will require Regulated Entities to (i) clearly communicate with borrowers for resetting the tenor and/or EMI; (ii) provide options for switching to fixed-rate loans or foreclosure of loans; (iii) disclose various charges incidental to the exercise of the options; and (iv) ensure proper communication of key information to borrowers. These measures will further strengthen consumer protection.

Consolidation and Harmonization of Instructions for Supervisory Data Submission

The Reserve Bank has, from time to time, issued several guidelines on the submission of supervisory returns by supervised entities. It has been decided to consolidate and harmonize such guidelines into a single Master Direction to reduce the compliance burden and to promote greater ease of doing business for supervised entities.

Conversational Payments and Off-line Capability on UPI; Enhancement in Transaction Limit of Small Value Off-line Digital Payments

With the objective of harnessing new technologies for enhancing the digital payment experience for users, it is proposed to (i) enable “Conversational Payments” on UPI, which will enable users to engage in conversation with AI-powered systems to make payments; (ii) introduce offline payments on UPI using Near Field Communication (NFC) technology through ‘UPI-Lite’ on-device wallet; and (iii) enhance the transaction limit for small value digital payments in off-line mode from ₹200 to ₹500 within the overall limit of ₹2000 per payment instrument. These initiatives will further deepen the reach and use of digital payments in the country.

Public Tech Platform for Frictionless Credit

The Reserve Bank, in association with the Reserve Bank Innovation Hub (RBIH), started a pilot project in September 2022 for frictionless credit delivery through end-to-end digital processes, starting with Kisan Credit Card (KCC) loans. The pilot for KCC loans is currently operational in select districts of Madhya Pradesh, Tamil Nadu, Karnataka, UP, and Maharashtra. Recently, dairy loans have been included in the pilot project in select districts of Gujarat.

Based on the learnings from the pilots and to expand the scope of end-to-end digital lending processes, a Public Tech Platform for Frictionless Credit delivery is being developed by the RBIH. The Platform is intended to be rolled out as a pilot project in a calibrated manner. It will have an open architecture and open Application Programming Interface (API) and Standards, to which all financial sector players can connect seamlessly. This initiative will accelerate the penetration of credit to hitherto underserved regions and further deepen financial inclusion.

Conclusion

We have made good progress in sustaining India’s growth momentum. While inflation has moderated, the job is still not done. Inflationary risks persist amidst volatile international food and energy prices, lingering geopolitical tensions, and weather-related uncertainties. In charting the course of monetary policy, we continuously assess the impact of our past actions, the evolving inflation dynamics and the implications of incoming data for the economic outlook. I reiterate our commitment to align CPI inflation to the 4 per cent target on a durable basis. We do look through idiosyncratic shocks, but if such idiosyncrasies show signs of persistence, we have to act.

As we prepare to celebrate Independence Day, the air is filled with hope and promise. Let me end by recalling the prophetic words of Mahatma Gandhi “…I have no doubt that our country would rise to the greatest height among the nations of the world.”

RBI Governor’s statement-important footnotes

·         During the accommodative phase of monetary policy, i.e., February 2019 to March 2022, the weighted average domestic term deposit rate (WADTDR) on fresh deposits of scheduled commercial banks and the weighted average lending rate (WALR) on fresh loans had fallen by 259 basis points and 232 basis points, respectively, in response to the repo rate cut of 250 basis points

·         In the recent tightening phase, i.e., May 2022 to June 2023, the repo rate has increased by 250 basis points, fully offsetting the reduction in the easing phase. However, the increase in the WADTDR on fresh deposits and the WALR on fresh loans at 231 basis points and 169 basis points, respectively, trails the reduction seen in these rates during the accommodative phase

·         The capital expenditure by the Central government increased by 59.1 per cent (y-o-y) during Q1:2023-24. The information available for 20 states indicates that their capital expenditure jumped by 74.4 percent (y-o-y) during Q1:2023-24 as compared with a contraction of 8.7 percent a year ago

·         The capital-to-risk-weighted assets ratio (CRAR) and the common equity tier 1 (CET1) capital ratio of SCBs were at historical highs of 17.1 percent and 13.9 percent, respectively, in March 2023. SCBs’ gross non-performing assets (GNPA) ratio continued a downtrend and fell to a 10-year low of 3.9 percent in March 2023, while the net non-performing assets (NNPA) ratio declined to 1.0 percent

·         The forex reserves are accumulated by RBI when the capital inflows are strong. Similarly, when forex outflows cause excessive volatility in the exchange rate of the Indian Rupee, the RBI supplies US dollars to the market to curb volatility and ensure that there is adequate forex liquidity. Thus, forex reserves are like an umbrella to use during rainy days

Highlights of opening statement by RBI Governor Das: 10^th August’2023

·         India is emerging as the new growth engine for the world. In a highly volatile and uncertain world, India is standing out for its resilience and stability

·         Monetary Policy has made significant progress towards price stability. The recent spike in CPI inflation, as I have already stated in the Policy Statement and even in the resolution, is expected to be short-lived going by past trends. In such situations, we need to remain watchful and not resort to any knee-jerk reactions

·         If these idiosyncrasies in CPI inflation and food inflation, in particular, show signs of getting generalized then we have to act, and this is what I have also said in the statement. We have to go beyond maintaining Arjuna's eye to deploy actual policy instruments. Let us remember in this context that the deployment of policy instruments is not just in terms of rate and stance, there are other ways of dealing with it. We have done our bit with regard to the incremental CRR today

·         With regard to incremental CRR, this was considered necessary in the background of the liquidity overhang. We considered it desirable in the interest of price stability and financial stability. It will have an impact on the inflation situation also. It is a purely temporary measure, and it will be reviewed on September 8 or earlier. We will ensure, as we have said, that there is adequate liquidity available in the system to meet the credit needs of the economy

·         We have done our internal assessment. If you recall, I paused during the statement and I said that we have done our internal assessment, and our assessment shows that there will still be adequate liquidity left with the banking system to maintain their lending activities, which they have been doing. Let me also add that we are sensitive to the cash requirements ahead of the festival season, which should be kicking in the latter part of September or early October

·         On the liquidity situation, let me add that there are at times pressures on liquidity because of the withdrawal of ₹2000 banknotes with 87% of it coming as bank deposits. So, there is a liquidity overhang, there is a liquidity excess that has to be dealt with

·         But even with that, there are periods when, as we have seen in the past and as we may see even in the coming months, there could be pressures on liquidity, especially in situations or at times when liquidity held in the system goes into the government coffers at the time of the tax payments, and this happens particularly around the time when advance tax payments are made with regard to direct taxes or 20^th of every month when GST inflows also happen

·         However, we have seen in the past that after a few days, it returns to the system because government expenditure ensures that the money comes back into the system. So, there are temporary pressure times on the liquidity situation, which lasts for about three to four days and sometimes maybe five days but it goes back into the system. So, this was on the incremental CRR and on the liquidity situation, what I wanted to say, this was the third point

·         The financial sector stability is well maintained. Stability is a public good and market participants and financial institutions have an equal share in preserving financial stability. We, from the Reserve Bank, look forward to their cooperation in this regard

·         The external sector is also resilient, foreign exchange reserves are strong, the umbrella has gained further strength and that gives a lot of confidence and comfort to the market

Highlights of RBI MPC Presser and Q&A (RBI Governor Das and Dy. Gov. Patra): 10^th August’2023

·         Expecting a boost to private CAPEX in the coming days in all productive sectors of the economy amid twin-balance sheet advantage and favorable macro-economic conditions for investment

·         “-- at the moment in this situation, there is a twin-balance sheet advantage. The balance sheets of banks and the balance sheets of corporates both are strong, and the balance sheets of corporates are quite deleveraged. So, there is space for making investments. Otherwise, it depends on individual companies”

·         “In my statement, I have very clearly stated that private investments are happening only in the critical sectors like iron and steel, automobiles, petroleum, metals, and chemicals sectors. So, investments are happening in many key sectors. Therefore, going forward, it should happen in other sectors as well because the ground conditions are favorable for investments”

·         I-CRR (additional 10% on NDLT for a limited period) may absorb a little above Rs.1T from the banking system, which occurs mainly because of the return of 2000/- currency notes

·         The so-called system liquidity of around Rs.3.5T (durable optimum liquidity) is not sacrosanct and RBI will always ensure sufficient liquidity as per the current and evolving macro-economic situation by both Repo and Reverse Repo operations

·         The headline/total CPI at +4.3% in May was at comfortable levels of RBI (aligned with the +4.0% target); but since then CPI surged on surging food inflation, which RBI expects to normalize in the coming months; RBI is watchful, but will not take any knee-jerk rate action

·         RBI will not disclose GSEC bond buying by any sovereign entity like Russia as a result of the settlement of some trade in INR, but there should not be any huge liquidity impact once matured (because INR is a local currency)

·         Going forward, the 14-day VRRR  will continue to be the main instrument to absorb liquidity despite recent operations of 1-4 day VRRR to deal with exceptional situations

·         Liquidity adjustment decisions involving I-CRR are an internal decision of RBI, not MPC’s and thus RBI may adjust it on or even before 8^th September as per the evolving liquidity situation ahead of Festival season; RBI will ensure sufficient liquidity ahead of Festival season

·          The I-CRR increase is also a step towards absorbing additional liquidity, which may contain surging headline CPI to some extent; looking forward, RBI will continue to be watchful

·         Any sudden Russian oil import-related trade deficit (estimated around $10-22B) outflow under any hypothetical situation is not an issue for RBI, considering the present FX reserve level of above $600B and RBI’s targeted FX intervention; but RBI believes such situation will not arise

·         RBI sees upbeat private CAPEX in the coming days amid robust rural as well as urban consumption

·         Currently, RBI thinks I-CRR is the best LAF instrument to adjust excess liquidity because of the return of 2000/- notes; but other instruments are also at the disposal

·         Now the possibility of an extension of monsoon is a concern for Rabi Corp cultivation, but overall RBI sticks to normal monsoon

·         Chinese deflation/slowdown is a global concern including India; but even if China grows around +5.2% in 2023, it would be decent, considering the size of the Chinese economy

·         External trade is weak, but import is decelerating more than export, resulting in lower BOP, positive for India

·         RBI is closely watching the food inflation trajectory mainly led by tomato, onion and potato; if it gets entrenched/sustained, then RBI has to take some policy action, but RBI is also looking for government policy intervention and other cyclical issues to resolve supply chain problem

·         RBI is aware of the total banking write-off figure of around Rs.15T for the last 10 years, but these write-off amounts are being parked into a special account (AUC-Advance Under Collection) for recovery until fully settled under some compromise settlement/NCLT road with some waive off (permanent loss); RBI likes to see better recovery from such AUC/write off accounts

Fed’s probable policy action in the rest of H2CY23:

Overall, the YTD (2023) average of underlying core CPI inflation is now around +5.3% and core PCE inflation +4.5%; overall average core inflation (CPI+PCE) is around +4.9% (~5.0%) against the Fed’s current repo rate of +5.50%; i.e., the real repo rate (wrt core inflation) is now around +0.5% (real positive) and at the mid-zone of Fed’s restrictive rate zone (5.00-6.00%).

Although the Fed officially targets core PCE inflation, Fed Chair Powell makes it quite clear that the Fed is now also targeting core CPI inflation to bring it down to +2.0% targets. Also, core service inflation is still quite elevated and sticky, although goods inflation has turned almost negative (deflation). The divergence between core PCE and core CPI inflation continues to be around +1.0% due to differences in constituents and weightage.

In this way, the Fed is now preparing the market for another hike in November and then a possible end of the tightening cycle by Dec’23. Overall, the U.S. labor market and core inflation trajectory are still hot enough for another Fed hike. Fed never surprised the market with its rate action and by mid-October (after core inflation and labor/wage data for July-September), it will be clear whether the Fed will go for another +25 bps hike in Nov’23 before going for a pause in Dec’23.

As per Taylor’s rule, for the US:

Recommended policy repo rate (I) = A+B+(C+D)*(E-B) =0.00+2.00+ (0+0)*(5.50.00-2.00) =0+2+3.50=5.50%

Here:

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 (CPI+PCE) =5.50% (for 2022); now average core inflation (CPI+PCE) is around +5.0% for 2023 (YTD); 6M average core inflation (2023) around +4.95%

Fed may go for a pause on 20^th September but may hike another +25 bps on 2^nd November, if core inflation does not fall significantly. Fed may go for a long pause to assess the underlying core inflation trend and outlook along with the labor market for July-Sep’23 economic data. Fed may project at least another hike in 2023 in its September dot-plots (SEP) depending upon the actual economic data and outlook. If there is no significant easing of core inflation, especially core service inflation, then the Fed may go for another +25 bps hike in Nov’23 and possibly the end of a tightening cycle.

Fed may now go for a long pause, at least till 1^st November’23, to assess the underlying core inflation trend and outlook along with the labor market for July-September ’23 economic data. If core CPI inflation indeed eased further to around +4.0% by Oct’23, then the Fed may refrain from any further rate hike in 2023 and may also indicate some rate cuts in Q2CY24 in the Dec’23 SEP (ahead of the US Presidential Election in Nov’24) to keep real repo rate around +1.00% levels (restrictive zone).

At the current run rate/trend, core CPI inflation should be around +4.0% by Dec’23, +3.0% by June’24, and +2.0% by Dec’24; i.e. at target ahead of the Fed’s estimate of Dec’25. But looking at the overall trend, higher oil prices, and core CPI inflation may also spike again in August-September.

Also, oil prices may stay elevated in the coming months between $75-85 instead of the earlier $65-75 despite US efforts to bring more supply from Iran, and Venezuela (by lessening sanctions) as OPEC/Saudi Arabia will not ‘cooperate’ with the U.S. for ‘breach of trust’ in refilling SPR (as agreed ‘verbally’). Elevated oil prices around $80 will continue to boost energy/transportation costs and core inflation. Saudi Arabia/most OPEC producers and even Russia are now seeking $80 oil prices on a sustainable basis to fund budget deficits, EV transition, and also the cost of the Ukraine war. China may also deploy more targeted stimulus to bring out the economy from the deflationary spiral in the coming days, which may also support elevated oil prices.

The U.S., as a producer, is also benefitting from elevated oil prices. The U.S. is also a beneficiary of the Russia-Ukraine war and other geo-political tensions involving North Korea, China, and Iran. The U.S. defense/military industry is now booming. Also, the lingering Cold War mentality with China is resulting in supply chain disruptions and elevated inflations. The global economy continues to face daunting challenges of macro-headwinds- elevated inflation, high levels of debt, tight and volatile financial conditions, continuing geopolitical tensions, fragmentations, and extreme weather conditions.

In any way, if average U.S. core CPI inflation indeed falls below +4.0% by June’24 (H1CY24) on a sustainable basis, the Fed may go for a +25 bps cut each in July’24 (just ahead of the Nov’24 US Presidential Election) and thereafter every alternate meeting to keep the real repo rate around +1.0% (from 3M/6M average core inflation).

Looking ahead, from March ’24, the Fed may try to balance the financial/Wall Street stability and price stability by expressing intentions to cut from June’24 (H2CY24) to ensure a soft landing while bringing down inflation. Also, the Fed has to ensure lower borrowing costs for the U.S. Government (Treasury) endless deficit spending and mammoth public debt of almost $32T. The U.S. is now paying around 9.5% of its revenue as interest on public debt against China/EU’s 5.5%. This is a red flag, and thus Fed has to operate in a balancing way while going for calibrated hiking to bring inflation down to target, avoiding an all-out recession; i.e. to ensure both price stability and soft-landing.

Conclusions: RBI continues the hawkish hold stance with an eye on the Fed’s policy action in the rest of 2023

The RBI may want to maintain the present policy rate differential of 1.50%-2.50% with the Fed depending upon the actual core inflation differential/trajectory. Thus RBI paused in August but has not pivoted as RBI may want to see actual Fed rate action and SEP on 20^th September and any guidance for the November/December meeting.

As per Taylor’s rule, for India:

Recommended policy repo/interest rate:

(I) = A+B+(C+D)*(E-B) =0.50+4+ (1.5+0)*(5.5-4) =0.50+4+1.5*1.5=0.50+4+2.25=6.75%

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=5.5% (for FY: 23-24)

Thus assuming the estimated average core inflation is around +5.50% in FY: 23-24, the restrictive target of the RBI repo rate may be around +6.75%. If the Fed continues to hike another +25 bps in H2CY23 (even after Sep’23 expected pause) to +5.75% by Dec’23 (in case U.S. core inflation remains sticky/elevated above +5.50%), then RBI also has to hike (under still elevated/sticky core inflation). Thus RBI may also like to keep the repo rate at 6.75% in CY23 (depending upon the Fed rate action and actual Indian core inflation trajectory/outlook).

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 inflation/growth narrative) to control imported inflation. India’s real rate was around +1.25% in Feb’19 if we consider the then repo rate of +6.50% and core CPI +5.25%. Now around +5.00% average core CPI and +6.50% RBI repo rate, the real repo rate is around +1.50%, consistent with RBI’s restrictive preference of 1.50% (1.00-2.00%).

Bottom line:

Under Governor Das and Modi admin, RBI may prefer to keep the real rate of interest around 1.50%. As India’s core CPI is now averaging around +5.50%, RBI may keep the terminal rate between 6.50%-6.75% in the coming days depending upon the actual Fed rate action and domestic core inflation trajectory. As there are a series of state elections in 2023 and also a general election by May’24, the Modi admin now prefers lower inflation than emphasizing too much on economic growth. Thus RBI may keep the terminal repo rate around 6.50-6.75% if the Fed does not go beyond +5.75% and India’s core CPI stays around +5.50%. Modi admin/BJP is now quite concerned about general elevated inflation, especially for food and fuel, which cost them the recent Karnataka state election dearly. In his recent speech on 15^th August, India’s PM Modi also emphasized repeatedly on price stability.

Overall, RBI is quite optimistic about India’s GDP growth but is still concerned about elevated sticky core inflation. But RBI is also quite optimistic about maintaining India’s price, financial, and growth stability through its calibrated policy action. As India’s core CPI is still substantially higher than targets, while real GDP growth is almost in line with the potential trend/target, RBI is still open for another calibrated +25 bps rate hike. If the Fed indeed goes for another rate hike in H2CY23 for a repo rate of +5.75%, RBI may go for at least another +25 bps rate hike by Dec’23 for a corresponding repo rate of +6.75%. And if the Fed goes for no further rate hike in H2CY23 for a terminal repo rate of +5.50%, RBI may continue to hold at +6.50% in FY24.

Looking ahead, the Fed may not be in a hurry to cut rates in H1CY24 but may cut rates in H2CY24 (from July’24 onwards, just ahead of the Nov’24 U.S. Presidential election). In his recent speech, RBI Governor Das stressed higher for longer policy. Thus RBI also may not cut before Aug’24.

In India, RBI also thus has to think about cutting from August ’24 onwards to match with the Fed; otherwise, if RBI goes for any pre-emptive cut in April’24, ahead of the Indian general election in May June, then USDINR may scale above 85, which would be a political issue. But Modi/BJP may also advance the general election in Dec’23 for various political, economic/budget, and weather-related issues. In this way, this time PM Modi is set to return with a big margin; the question is whether it’s 300+ 350+ or 250+ seats against the 2019 verdict of 300+ seats. But growing popularity of various regional opposition political parties including INC at state levels may be an issue for coherent policy implementation of Modi admin across India.

Technical Analysis: Nifty Future (LTP: 19314)-EOD: 28/08/23

Looking ahead, whatever may be the narrative, technically, Nifty Future now has to sustain over 19200-19150 for a rebound to 19500/19600-19700/19875 and 20000-20050*/20100-20250*/20375 and 20650/21050-21550/21650 in the coming days (Bullish case scenario). On the flip side, sustaining below 19100 Nifty future may again fall to 18940/18800-18660/18600* and further 18400/18000-17850*/17650 zones in the coming days (Bearish case scenario).

Now the next market move will depend upon Fed action/commentaries about rates in September and November. Dow Future may now recover to 35700 levels from around 34000 if the Fed indicates a pause in September, but going forward, if the Fed indicates another hike in November, then Dow Future may again fall from around 35700 to 34000 levels. And India’s Nifty future bounds to follow Dow Future despite the narrative of some decoupling story.

 

 

 

 

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