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RBI June MPC minutes show hawkish hold stance continuation
RBI may hike in Dec’23 by +25 bps for a terminal rate of +6.75% if Indian core CPI again surges towards +6.00% and Fed goes for two hikes in H2CY23
India’s benchmark stock index Nifty made a fresh lifetime high of 19010.00 Wednesday (28th June) on an FII boost amid improving domestic macros, the appeal of Modinomics, India’s 6D (demand, demography, democracy, deregulation, development, and digitalization) and political & policy stability. India’s Dalal Street was also boosted by positive cues from Wall Street on easing of Russian regime change tension and hopes & hypes of Fed pivot. The market is now also expecting a similar RBI pivot.
On Thursday (22nd June), Nifty scaled almost Dec’22 lifetime high of 18887.60, but soon stumbled almost -240 points and closed around 18665.50 Friday on hawkish RBI minutes and Fed talks, indicating the clarification that the present pause may not be taken as a pivot.
Fed may hike another +25/50 bps by Dec’23 as U.S. core inflation, now around +5.2% (3M rolling average), is still quite elevated and sticky. Similarly, India’s RBI may also hike at least once (+25 bps) by Dec’23 to keep policy rate parity with Fed to control imported inflation. Also, India’s core inflation, now around +5.3% (3M rolling average), may warrant at least another +25 bps hike to keep the repo rate at +6.75% for at least H1CY24 in a sufficiently restrictive zone to align core inflation durably around +4.00% targets.
On Friday (23rd June), Nifty was also dragged by the Adani group of stocks after an unconfirmed report that the beleaguered group may now face U.S. SEC regulatory scrutiny in the U.S. over its response to the Hindenburg short seller’s report, alleging various irregularities and frauds (corporate governance issues). Also, the highly leveraged Adani group is taking a fresh loan for around $123M to finance its data center business.
Nifty was also dragged by RIL as the company is taking debt for JIO capex. Also, RIL is concerned about a possible entry of Tesla CEO Musk’s Star Link entry in India for satellite-based internet linking, which may harm the JIO market. RIL has officially lodged a letter protesting against any plan to provide such satellite link spectrum to Musk’s Star Link without any auction route. India’s PM Modi has met Tesla Chief Musk and also Amazon CEO in the U.S. for investment/more investment in India. These two companies may pose serious threats to Ambani/RIL for telecom/broadband/internet and also a retail/e-commerce and digital streaming business. Techs were also under stress on subdued guidance by Accenture, which is seen as a proxy for Indian IT service exporters like TCS, Infy, etc.
On Wednesday (28th June), RBI released its latest Financial Stability report: Highlights:
· The global economy is facing heightened uncertainty amidst banking system fragility in certain countries, persisting geopolitical tensions, and moderating but elevated inflation
· Despite global headwinds, the Indian economy and the domestic financial system remain resilient, supported by strong macroeconomic fundamentals.
· Continuing growth momentum, moderating inflation, narrowing current account deficit and rising foreign exchange reserves, ongoing fiscal consolidation, and a robust financial system are setting the economy on a path of sustained growth.
· Healthy balance sheets of banks and corporates are engendering a new credit and investment cycle and brightening the prospects of the Indian economy.
· The capital-to-risk-weighted assets ratio (CRAR) and the common equity tier 1 (CET1) ratio of scheduled commercial banks (SCBs) rose to historical highs of 17.1 percent and 13.9 percent, respectively, in March 2023
· SCBs’ gross non-performing assets (GNPA) ratio continued its downtrend and fell to a 10-year low of 3.9 percent in March 2023, and the net non-performing assets (NNPA) ratio declined to 1.0 percent.
· Macro stress tests for credit risk reveal that SCBs would be able to comply with the minimum capital requirements even under severe stress scenarios. The system-level capital to risk-weighted assets ratio (CRAR) in March 2024, under baseline, medium, and severe stress scenarios, is projected at 16.1 percent, 14.7 percent, and 13.3 percent, respectively.
The RBI Governor Das said in the latest bi-annual (June) Financial Stability report:
“Over the last three years, the global economy has been navigating successive high-amplitude shocks: the COVID-19 pandemic waves; protracted geopolitical hostilities; rapid monetary policy tightening; and the recent banking turmoil. Economic fragmentation is threatening macroeconomic prospects, especially among emerging markets and developing economies (EMDEs).
Despite these heightened uncertainties and formidable headwinds, the Indian economy has made a solid recovery and is among the fastest-growing large economies. In this fragile global milieu, balancing the policy trade-offs, preserving macroeconomic and financial stability, shoring up confidence, and supporting sustainable growth are top priorities for policymakers the world over.
Since the last issue of the Financial Stability Report (FSR) in December 2022, the global and Indian financial systems have charted somewhat different trajectories. The global financial system has been impacted by significant strains since early March 2023 from the banking turmoil in the U.S. and Europe. In contrast, the financial sector in India 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. Both banking and corporate sector balance sheets have been strengthened, engendering a ‘twin balance sheet advantage’ for growth. The reach and depth of financial intermediation are being aided by technology and growing digitalization, which provide new opportunities for growth and financial inclusion.
As the recent banking turmoil in certain advanced economies (AEs) suggests, new risks have necessitated a reassessment of global standards on financial sector regulations. While international cooperation among regulators on these issues is of paramount importance, so far as India is concerned, both regulators and regulated entities need to stay the course with an unwavering commitment to ensuring a stable financial system. It has to be remembered that seeds of vulnerability often get sown during good times when risks tend to get overlooked.
International cooperation and regulatory focus are also needed to tackle other challenges, such as cyber risks and climate change. Through its G20 presidency, India is striving to improve the efficacy of multilateralism in several such areas. These efforts are fittingly captured in India’s theme for G20: One Earth, One Family, One Future.
Financial stability is non-negotiable, and all stakeholders in the financial system must work to preserve this at all times. The Reserve Bank and the other financial regulators remain steadfast in their commitment to safeguarding financial stability in the face of potential and emerging challenges.”
The Indian market was boosted by political & policy, macro & currency stability:
If we consider India’s goods+ service export/import, the net trade deficit was around $-122.00B in FY23 vs. -81.90B in FY22; but if we consider remittances and FDIs along with other Capital account entries, the net BOP was around -$0.10B in FY23 against +0.10B in FY22. As India/Modi admin is now emphasizing domestic manufacturing (Made in India), India’s risk of FX currency shortage is now getting minimal; also, India’s net external debt is negligible, which is a big beneficiary of the country’s macroeconomic stability. India also has stable inflation due to calibrated/prudent RBI monetary policy action (to address demand) along with appropriate fiscal intervention to address supply chain issues.
Also, INR is not convertible in capital accounts; i.e., Indians are not eligible to hold any FX currency/USD without a special purpose (like specific payment or investment overseas under LRS). Thus India may never turn into an unstable economy like Pakistan, Sri Lanka, Argentina, Brazil, or even Greece. Also, present political & policy stability is a great advantage for India under the leadership of PM Modi, and thus, India is now enjoying a scarcity premium, and FIIs are pumping amid FOMO (fear of missing out). And the stability of INR is also attracting robust FPIs. India’s thrust on infra spending is also helping (without causing elevated inflation).
On Thursday (22nd June), RBI published minutes of the MPC meeting of 8th June: RBI goes for a hawkish hold.
Statement by Dr. Shashanka Bhide: MPC member-External
“Since the April meeting of the MPC, the GDP growth numbers for FY 2022-23 have been updated, and we also have the headline inflation numbers for April 2023. The official provisional estimates (PE) for GDP at constant prices place the GDP growth higher at 7.2 percent for FY 2022-23 from 7 percent in the Second Advance Estimates. The headline YOY inflation rate in April dropped to 4.7 percent, well below the rate in March, 5.7 percent. A significant part of the improvement in GDP in FY 2022-23 was due to the growth in Q4 FY 2022-23 at 6.1 percent in comparison to the expectations of growth of 5.1 percent implied by the overall growth rate of 7 percent in SAE. The better-than-anticipated growth in Q4 combined with the lower inflation reading for March-April reflect different sets of factors influencing growth and inflation.
The global macroeconomic conditions have continued to be adverse, reflecting slow growth momentum and moderating but elevated inflation pressures across economies. In addition, global trading opportunities have been limited by policies restricting supply chains. The recent events have also pointed to the vulnerability of the banking and financial sectors to monetary and fiscal policy stances. The energy markets experienced uncertainty in the face of the global economic slowdown and the protracted Ukraine war. The monetary policy measures aimed at curbing inflationary pressures in the major advanced and emerging market economies appear to be successful in moderating the inflation rate, although the rates remain well above the policy targets.
This provides an overall context for an assessment of the likely course of growth and inflation in the short to medium term. One important feature of GDP growth in 2022-23 and also 2021-22 was the dominance of Q1 compared to the other quarters. As the pandemic-induced sharp decline in GDP in Q1 of 2020-21 is offset by the subsequent growth, growth in Q1:2023-24 is likely to be closer to the growth across quarters.
A second feature of growth performance in 2022-23 is the uneven performance across sectors. Manufacturing growth reflected in the growth of Gross Value Added (GVA) is placed at 1.3 percent compared to the growth in construction (10.0 percent) or the services sector (9.5 percent). While the input cost pressures in 2022-23 appear to have had a greater impact in the case of manufacturing than in the other sectors, slower growth of consumer spending and investment would also have affected demand for manufacturing more than the others.
Finally, the deceleration in export demand would affect manufacturing output. Going forward, a reduction in cost pressures and overall inflation and a revival of exports would be important in accelerating manufacturing growth. The indicators compiled by RBI for listed manufacturing companies in Q4: 2022-23 indicate significant improvement in profit margins with increased GVA growth and sustained improvement in capacity utilization during the year are positive for the revival of manufacturing growth in 2023-24. However, there are segments within the manufacturing sector where a weak export environment would be a concern.
The services sector was the growth driver for the economy in 2022-23. The revival of demand in the service sectors badly hit during the pandemic, has sustained the growth of the overall sector. GVA growth in the sub-sector Trade, Hotels, Transportation, and Broadcasting in 2022-23 is still only 4.1 percent over its pre-pandemic level in 2019-20, with considerable upside potential of the sub-sector for growth. The export of services is expected to be adversely affected by the global economic slowdown in 2023-24.
In the case of agriculture and allied sectors, GVA growth in 2022-23 turned out to be higher than in 2021-22, although there were adverse weather effects during the year. The normal monsoon forecast by the Indian Meteorological Department, despite the emergence of the El Nino phenomenon, would be supportive of agricultural growth.
On the demand side of the economy, RBI’s recent sample surveys of households and enterprises indicate improving consumer sentiments and business outlook for 2023-24. The improvement is, however, in comparison to a period of weak sentiments through 2022-23. Early results of the enterprise surveys indicate greater optimism on the part of services and infrastructure firms on demand conditions than in the case of manufacturing. The Consumer Confidence Survey of urban households conducted in May reflects a steady improvement in confidence for the current period and strengthening optimism on the ‘one-year ahead’ situation.
Expenditure expectations remain broadly stable with indications of increasing non-essential expenditure by the households. While cost pressures are expected to moderate in Q1, the expectation of rising costs – inputs, financing, and staff – is still widely shared, especially in Q2. Higher selling prices are seen to improve profit margins. In the sectors where demand is buoyant, the transmission of higher costs to selling prices would be greater. Overall, perceptions of cost pressures and selling prices vary across sectors.
The high-frequency indicators for the recent period of April-May provide a mixed picture. The urban and demand conditions show improvement and PMIs for manufacturing and services reflect rising output. However, there are also mixed signs of transport activity. Railway freight and port traffic and motor spirit sale show YOY growth rates of less than five percent but E-way bills and toll collections continue to register double-digit growth. External trade weakened in April. Non-food credit, a broader measure of economic activity, has increased by about 16 percent during April-May 2023.
The overall growth momentum for 2023-24 is expected to be more moderate than in 2022-23. The projections provided in the April meeting of the MPC hold over the improved official estimates for 2022-23. The GDP growth for 2023-24 is retained at a 6.5 percent YOY basis. The quarterly YOY growth projections are Q1: 8.0 percent, Q2: 6.5 percent, Q3: 6.0 percent, and Q4: 5.7 percent, respectively. The significant downside risks to growth are the unfavorable rainfall conditions during the monsoon season, steeper than expected decline in global demand conditions, and supply chain disruptions due to spillovers from the geopolitical conflicts. As compared to the April forecast, the quarterly growth rates in Q1 and Q2 are revised upward, and Q3 and Q4 downward in the present set of projections. RBI’s Survey of Professional Forecasters provides a median forecast of 6.0 percent for 2023-24, the same as in the previous round.
The headline inflation rate, YOY, dropped further to below the 5 percent mark in April, following the decline to below 6 percent in March. The rate of price rise fell in all three main categories of the consumption basket: food, fuel, and the ‘core.’ The decline was steeper in fuel and food than in the ‘core.’ This broad-based decline in the inflation rate was also seen in March.
A number of factors have contributed to the significant decline in the inflation rate in March and April: deceleration in the commodity prices in the international markets, decline in the inflation rates in the major economies, although they remain well above the targets; favorable base effects; and the impact of monetary and policy measures on inflation directly and through their impact on inflation expectations. RBI’s recent Inflation Expectations Survey of Urban Households finds that along with the perceived current inflation rates, the median expected inflation rate on a 3-months ahead and one-year ahead horizon is declining as compared to their levels in the previous round.
Taking into account the current trends and assessment of factors influencing price trends, RBI’s projected average headline inflation rate for FY 2023-24 is 5.1 percent, with quarterly projections of 4.6 percent in Q1, 5.2 percent in Q2, 5.4 percent in Q3, and 5.2 percent in Q4. The projected inflation rate for FY 2023-24 is well below the rate of 6.7 percent experienced in the previous year and close to the median forecast of 5.0 percent for FY 2023-24 in the RBI’s Survey of Professional Forecasters.
However, a few concerns remain on the question of the sustainability of the trends seen in the March and April headline inflation rate. Several sub-categories of consumption baskets still register price rises of well above 6 percent. Price rise, YOY basis, in the case of cereals and products, is in double digits, and in milk and products, above 8 percent in March and April. Clothing and footwear and Household goods and services also are at or above the 6 percent rate of price rise in March and April.
Among the broad groupings of items in the consumption basket excluding (1) Food and beverages, (2) Pan, tobacco, and intoxicants, and (3) Fuel and light, items with a YOY price rise of 6 percent or more account for 45 percent of the weight of this broad group. The month-over-month change is higher in April as compared to March for several commodity groups although significant ‘base effects’ have lowered the YOY headline inflation rate. These issues require consideration in assessing the sustainability of moderating trends in the headline inflation rate to the target of 4 percent.
The decline in the overall headline inflation in the recent two months combined with the strong growth performance in Q4: FY 2022-23 suggest a trajectory of lower YOY inflation of 5 percent and GDP growth of above 6 percent in FY 2023-24. The projected inflation rate is below the upper tolerance limit of 6 percent but well above the target of 4 percent. There are also upside risks to inflation both on account of the evolution of sectoral price trends and developments at the global level. The impact of the increase in policy rate between May 2022 and April 2023 by 250 basis points and other economic policy measures have been crucial in anchoring price expectations.
As the transmission of the policy changes through the economy to reach the inflation target is subject to unpredictable developments, it is necessary to ensure that the policy framework is focused on achieving the inflation target while supporting growth.
Accordingly, I vote: to keep the policy repo rate unchanged at 6.50 percent and to remain focused on the withdrawal of accommodation to ensure that inflation progressively aligns with the target while supporting growth.”
Bhide is a known hawk; he is quite upbeat on economic growth but cautiously optimistic about lower inflation in the coming months due to elevated sequential reading of the core component; thus overall stance is hawkish hold.
Statement by Dr. Ashima Goyal: MPC Member-External
“Global uncertainty continues, although its economic impact has been less severe than expected. Major advanced economy (AE) central banks have slowed their tightening. Inflation is softening, although it continues to be above target. They have shifted to a more data-based approach and are more willing to wait for the lagged effects of past tightening. Inflation has not been high for as long as it was in the seventies, so there is less reason to fear persistence without higher for longer policy rates. Labor markets remain tight, but this may partly reflect labor hoarding by employers following the post-Covid-19 labor shortages so that tightness may be overestimated. AE fiscal tightening has less global spillovers compared to monetary tightening so more AE fiscal consolidation may reduce pressures on monetary policy.
Indian growth outperformed market expectations but did fall from 9.1% in FY22 to 7.2% in FY23. Some turnaround in manufacturing and continued growth in fixed investment in Q4FY23 augurs well for the future, however. Construction also remains robust, but consumption and exports have areas of softness, pent-up demand for services may moderate, and unemployment remains high.
Inflation has moderated into the tolerance band but is not yet firmly on the target path, particularly in view of monsoon-related uncertainties. Even so, it is clear that core inflation is neither persistent nor broad-based. Core inflation fell from 6.2% in January to 5.1% in April this year. Softening is to be expected in the absence of true second-round effects from excess demand or tight labor markets. Inflation was higher for so long because of multiple supply shocks.
Going ahead, firms’ input-output price gap is almost closed, profit margins rose sharply in Q4FY23, input costs have fallen, wage pressures are not there, and since demand is slack, they are unlikely to raise prices. WPI inflation, which has a larger weight than manufacturing prices, is negative. The IIM Ahmedabad business expectation survey shows a moderation in firms’ one-year-ahead price and cost inflation as well as sales expectations. Preliminary results from the RBI enterprise surveys, however, show firms expecting price and cost inflation to rise, despite actual costs and inflation softening. This may be due to fears about the monsoon and bears watching over the next few months.
The quick succession of repo rate raises has brought the real rate to near equilibrium levels, which has prevented overheating as well as over-tightening of demand and helped to anchor inflation expectations. The slowdown and pause were also well-timed.
It is necessary to build on the learning of the past few years, where allowing sufficient nominal variation in repo and exchange rates to keep real rates near equilibrium has helped smooth shocks and sustain Indian growth resilience. The experience has shown that independence from AE monetary cycles is feasible and foreign inflows are not tightly linked to the interest rate differential with AE rates. Flexibility in inflation targeting, intervention in FX markets to reduce excess volatility, economic diversity, supply-side action, and good monetary-fiscal coordination under supply shocks have all contributed to better outcomes.
As expected inflation falls, however, the real repo rate mustn't rise too high. This is what happened in 2015 as international oil prices fell, damaging the economic cycle. Research suggests that the inflation targeting regime has contributed to reducing inflation expectations. Commitment to such a regime only involves aligning the nominal repo rate with expected inflation. Such action, together with the greater impact of official communication in emerging markets, is adequate to bring inflation to target as the effect of shocks dies down. It does not require the nominal repo to be kept higher for longer.
But in this meeting, it is appropriate for the MPC to pause. I also vote for the present stance to continue since, at present, it is not possible to give a signal about future action. The latter will be conditional on the data coming in. The pause is only for the current meeting. Moreover, transient events have created a liquidity surplus, so that withdrawal of liquidity itself is also required.”
Although Goyal is a known dove and she also talked like the same (lower positive real rate for a shorter duration), she voted for the hawkish hike stance (pause for the current meeting only and no probability about cutting rates in late 2023.
Statement by Prof. Jayanth R. Varma: MPC Member-External
“The outlook on inflation and growth has changed only marginally between the April meeting and this meeting. The two inflationary risks that I spoke about in April (crude prices and the monsoon) have become a little less worrisome. On the crude oil front, it is now clear that OPEC+ is struggling to reduce supply adequately to counter sluggish demand, and the risk of a substantial spike in crude price in the near term is not very high.
As regards the monsoon, the official forecast of a normal monsoon provides some comfort, but it is tempered by the fact that the forecast includes an almost even chance of the monsoon being below normal or worse. Fortunately, the forecast likelihood of a deficient monsoon is only marginally higher than the climatological probability, and the chance of a drought appears to be rather remote. This augurs well because the Indian economy is quite resilient to a monsoon which is somewhat below normal if its spatial and temporal distribution is satisfactory. Another indication of a slight reduction in inflationary risks is the slight decline in the RBI projections of inflation for 2023-24 between the April and June meetings. Similarly, the outlook for growth remains more or less the same as in April, with several high-frequency indicators suggesting that growth is not as robust as we would like.
Considering the balance of risks, I vote to keep the repo rate unchanged in this meeting. I am of the view that the current level of the repo rate is high enough to keep inflation below the upper tolerance band on a sustained basis and also glide it toward the middle of the band. However, there are significant risks to both inflation and growth, and the process of bringing inflation under control is still very much a work in progress.
It would be premature to declare victory at this point based on the inflation prints of just a couple of months. In this context, I am not at all comfortable with the self-congratulatory tone of the statement in the MPC Monetary Policy Statement that “The MPC took note of the moderation in CPI headline inflation in March-April into the tolerance band, in line with projections, reflecting the combined impact of monetary tightening and augmenting supply measures.
Turning to the stance, I find that with every successive meeting, this stance is becoming more and more disconnected from reality. Based on the forecast inflation for 5.1% for 2023-24, the real repo rate is now almost 1½%. (The real short-term rate could well be above that level since in recent weeks, many money market rates have often drifted toward the MSF rate of 6.75%).
In other words, monetary policy is now dangerously close to levels at which it can inflict significant damage to the economy. Despite this, the majority of the MPC wishes to remain focused on the withdrawal of accommodation, whatever that phrase might mean. I have, therefore, seriously considered dissenting on this part of the resolution, but after careful thought, I have decided to confine myself to expressing reservations about it. The main reason for not dissenting is that, after two successive meetings at which the repo rate has been left unchanged, this stance now appears more vestigial than a serious statement of intent.”
Varma always maintains the contradictory stance of the majority RBI MPC; he was a hawk when RBI was cutting rates and now turned dove when raising rates. Varma now sees lower inflation risks but also likes to see the longer duration of a lower inflation trend –not just 1-2 months. Varma sees a sufficiently restrictive RBI repo rate at present of +6.50% as actual headline inflation is now near +5.00% (3M rolling average), and the RBI inflation forecast for FY24 is around +5.1%. Thus Varma is against the further withdrawal of accommodation or further tightening and preferred a pivot rather than pause, but he chose not to dissent officially, just expressed some reservation over the forward guidance stance of the RBI. Overall, Varma took a dovish hold stance.
Statement by Dr. Rajiv Ranjan: External MPC member
“The reasons outlined for a pause in rate action in my previous statement of April 2023 broadly hold for this meeting as well. Moreover, as the latest prints of growth and inflation indicate a Goldilocks scenario, with growth higher and inflation marginally lower than anticipated, this tells us that our cumulative actions taken so far are working in the right direction. It needs to be acknowledged, however, that knowing when to stop is hard. The effects of the tight policy will continue to percolate through the system months after the pause. If policymakers continue tightening until inflation falls as much as they want, they are likely to go further than they need to. Notwithstanding this, we mustn't drop our guard against inflation, especially when we are still away from our primary goal of aligning inflation to the 4.0 percent target.
On the domestic growth front, the optimism spelt out in my earlier minutes has materialized, with the acceleration in real GDP growth for Q4 2022-23 to 6.1 percent from 4.5 percent in the preceding quarter. The quarter-on-quarter (QoQ) seasonally adjusted momentum in Q4 at 2.9 percent, well above the pre-pandemic average of 1.7 percent (2012-13 to 2019-20), bodes well for growth going forward.
Furthermore, there are clear signs of economic activity holding up well in Q1:2023-242 as indicated by various high-frequency indicators and this optimism is expected to follow through in the remaining quarters of 2023-24. This stems from three factors: (i) revival in rural consumption; (ii) private corporate investment gaining steam; and (iii) moderating drag from net external demand. Let me elaborate. Rural demand is supported by the robust Rabi foodgrains production and expected normal monsoon.
Given the low share of agriculture in aggregate GVA (around 15 percent in 2022-23) and its contribution to GDP growth, even if the monsoon turns out to be lower than normal, its impact on growth may not be significant. On the other hand, a deficient monsoon could have a more tangible impact on inflation due to the higher share of food items in the CPI consumption basket.
There is an increasing revival in corporate investment due to the slackening of input cost pressures and rising capacity utilization. Credit growth to the industry has improved, driven by large industries, particularly roads, steel, cement, construction, petroleum, and chemicals.
On the supply side, manufacturing sector performance, which turned positive in Q4:2022-23, is likely to improve further with softening commodity prices, normalization of supply chains, and production linked incentive (PLI) scheme gaining traction. Manufacturing companies in several key sectors have expanded their fixed assets. The services sector constituted about 63 percent share in aggregate gross value added (GVA) and contributed around 83 percent to growth in GVA during 2022-23 and is expected to remain the mainstay of growth in 2023-24. Higher contraction in merchandise imports coupled with buoyant services exports are improving net external demand.
Headline CPI inflation fell sharply by 1.7 percentage points between February and April 2023, supported by favorable base effects and soft price momentum. The softening in core inflation was seen across various exclusion based as well as trimmed mean measures. CPI diffusion indices indicate that a majority of the CPI items saw price increases less than a seasonally adjusted annualized rate (SAAR) of 6 percent during March-April 2023, a significant reversal from February.
All these suggest some waning of price pressures in CPI in recent months, as the impact of monetary policy actions, supply-side measures, and easing of global commodity prices played through. Inflation, however, is likely to remain well above the target rate of 4 percent throughout the year.
We have been prudent in our approach using the flexibility embedded in the framework to operate within the tolerance band in balancing macroeconomic priorities depending upon the need of the hour. With greater clarity on macro fronts, prudence requires that we now focus on aligning inflation to the target of 4 percent. Time is opportune to emphasize the distinction between the inflation target and tolerance of deviations from the target.
The tolerance band can be conceptually broken down into an uncertainty range owing to imperfect knowledge of the (present and future) state of the economy; the indifference ranges over which monetary policy is not expected to react; and finally, the operational range that allows for intentional deviations to exercise short-run trade-offs between inflation and growth.
Sustained deviations of inflation from the target may lead to a steady drift of inflation expectations. The risk of ceding part of the operational range to the indifference range makes it imperative to emphasize the primacy of the 4 percent inflation target. This is crucial to support the ongoing process of anchoring inflation expectations around the target. Moreover, the real policy rate continues to be positive which will further anchor inflation expectations.
The rate pause in April seems to have had a sobering impact on domestic financial conditions. For instance, the average spread of the 10-year G-sec yield over the 1-year G-sec, 91-day Treasury bills, and the policy repo rate moderated to 20 bps, 29 bps, and 58 bps, respectively, from April 6-June 7, 2023. In the credit market, the weighted average lending rate (WALR) on fresh rupee loans and the weighted average domestic term deposit rate (WADTDR) on fresh deposits of scheduled commercial banks fell by 23 bps and 12 bps, respectively, in April 2023.
Such an easing of financial conditions occurred, even as the MPC had unequivocally argued that the pause was specific to the April policy and not a policy pivot. Accordingly, continuity in the stance with a clear-cut objective of aligning inflation to the 4 percent target is important. Any premature change in stance may be hasty and could undo the hard work done so far. It may also tamper with the transmission process that is currently underway.
Recent actions of some advanced economies reverting back to rate hikes after a pause needs to be kept in mind. Thus, I vote for a pause in rate action and continuity of stance. Monetary policy actions would need to be calibrated carefully by assessing the impact of past actions, meticulously scrutinizing the incoming data, and responding appropriately to the evolving macroeconomic conditions.”
Ranjan is a known hawk, and he kept his hawkish hold position as Indian economic growth is quite upbeat, while core inflation is still substantially running above +4.0% targets. Thus there is a need to maintain a hawkish policy to control inflation expectations (psychology) and actual inflation.
Statement by Dr. Michael Debabrata Patra: RBI Dy. Governor (MPC)
“Macroeconomic outcomes have broadly evolved along projected paths, vindicating the April 2023 monetary policy decision and stance. This provides elbow room to re-assess the evolving outlook with information gleaned from current rounds of forward-looking surveys and updated forecasts of goal variables while keeping in mind the cumulative actions already taken and the lags of monetary policy’s effects on the economy.
Overall, the outlook for real GDP growth in India is brighter than in April. Global risks appear contained for now, but idiosyncratic monsoon-related risks have risen and need to be seen off over the ensuing months. Financial conditions have eased considerably, and domestic financial markets are reflecting a stable growth outlook along with the re-anchoring of inflation expectations.
The near-term outlook for inflation is also relatively benign vis-a-vis the 2022-23 experience. Beyond the first quarter, however, pressure points emanating from specific supply-demand mismatches could impart upward pressure on the momentum of prices and offset favorable base effects, especially in the second half of 2023-24. Hence, monetary policy needs to remain in ‘brace’ mode, ensuring that the effects of these shocks dissipate without leaving scars on the economy.
Accordingly, my vote for maintaining the status quo on the policy rate should be seen as taking the middle stump guard to prepare for a bouncier pitch. Holding the rate unchanged should not be interpreted as the interest rate cycle has peaked, but as a period of careful evaluation of a decision on the extent of additional policy tightening, if needed.”
This is a part of continuous learning about the underlying structure of the economy with new information until the next meeting of the MPC, and not a prolonged pause. Headline inflation is edging down towards the target, but it is still well above it, and the balance of risks suggests that it will go up in the coming months before it comes down. Therefore, continuing with the stance of withdrawal of accommodation is appropriate as it adequately conveys the future course of interest rates in the economy.”
RBI Dy. Governor Patra is now turned into a hawk/owl for the last few months (from earlier dove -founder ‘Indian/Desi’ version of QE). Patra now argued that as Indian economic growth is quite strong (at/near RBI target of maximum growth), but core inflation is still elevated and substantially above RBI targets (even after some easing), RBI should maintain the hawkish policy stance. Also, Patra pointed out that inflation may again surge in the coming months as favorable base effects fade and monsoon/supply-related risks.
Statement by Shri Shaktikanta Das: RBI Governor (MPC)
“The global economy has sustained the growth momentum, and the overall uncertainty is somewhat receding. Nevertheless, headwinds to the global growth outlook persist. The geopolitical conflict continues unabated. Headline inflation across countries is on a downward trajectory but is still high and above their respective targets. Central banks remain on high alert and watchful of the evolving conditions.
India’s macroeconomic fundamentals are strengthening, and growth prospects are steadily improving and becoming broad-based. Inflation has eased and the external sector outlook has improved. Balance sheets of banks and corporates look resilient and healthy, thereby engendering twin balance sheet advantage for growth. Demand conditions remain supportive of growth on the back of improving rural demand and investment activity. Urban demand remains strong. Consumer and business outlook surveys display continued optimism. Overall, the Indian economy presents a story of resilience and sustainability, with an expected real GDP growth of 6.5 percent in 2023-24. Macroeconomic and financial stability is now well entrenched and needs to be nurtured and preserved with well-calibrated and timely actions.
The inflation trajectory has seen significant softening during March-April 2023, as anticipated, with the near-term outlook turning out to be more favorable than envisaged earlier. Inflation is now projected to average 5.1 percent in 2023-24 compared to 6.7 percent in 2022-23, but this would still be above the target. The disinflation towards the target rate of 4 percent is likely to be gradual and protracted. Compared to April, uncertainties on the inflation outlook for H2:2023-24 have not abated.
The spatial and temporal distribution of the southwest monsoon in the backdrop of a likely El Nino weather pattern needs to be watched carefully, especially for its impact on food prices. International prices for key food items like rice and sugar are at elevated levels. Adverse climate events have the potential to quickly change the direction of the inflation trajectory. Geo-political tensions, uncertainty on crude price trajectory, and volatile financial markets pose further upside risks to prices. These considerations warrant close monitoring of the evolving price dynamics.
The pause in April MPC was based on the need to assess the cumulative impact of the 250 bps rate hike over the past year. Our surveys indicate that anchoring of expectations is underway and our monetary policy actions are yielding the desired results. Given the baseline inflation projections for 2023-24, positive real policy rates will aid the ongoing disinflation process. The full impact of past actions is still unfolding. In this situation, a pause in the rate hike cycle and closely assessing the evolving situation look as the most appropriate option for this meeting of the MPC. Accordingly, I vote to keep the policy rate unchanged in this meeting of the MPC.
Our job is only half done, having brought inflation within the target band. Our fight against inflation is not yet over. We need to undertake a forward-looking assessment of the evolving inflation-growth outlook and stand ready to act if the situation so warrants. Beyond this and given the prevailing uncertainties, it is difficult to give any definitive forward guidance about our future course of action in a rate-tightening cycle.
I also vote to continue with the stance of withdrawal of accommodation, given that liquidity in the banking system is still in surplus, and we have a way to go to align headline inflation with the 4.0 percent target on a durable basis and ensure that the overall financial conditions are in sync with the monetary policy stance. We will continue to remain agile and flexible in managing liquidity through two-way operations. We do recognize that durable price and financial stability are mutually reinforcing and necessitate greater policy focus at the current juncture. Our future actions will be shaped accordingly.”
Overall, RBI Governor is maintaining the official stance that the pause is not a pivot. As the Indian economy is running quite hot, but core inflation is still quite elevated and substantially above +4.0% targets, RBI will maintain a hawkish stance and may not hesitate for further calibrated rate hikes in the coming months, if required to bring core inflation durably aligned with the +4.00% targets.
The next move of RBI will depend upon Fed rate action and the trajectory of India’s core inflation:
The overall stance of the RBI may be termed as hawkish hold as RBI clarified the present mode again as a ‘pause,’ not a ‘pivot’; i.e., RBI may go for further hikes in the coming months depending on the actual domestic core inflation trajectory and Fed action. On 8th June, Das also mentioned unexpected rate hikes by RBA (Reserve Bank Of Australia) and BOC (Bank of Canada) after pauses and expressed caution as India’s core inflation remains substantially above the +4.00% target.
The market was expecting a dovish hold from the RBI this time as India’s headline inflation (CPI) suddenly eased to an 18-month low of +4.7% in April, mainly due to favorable base effects and lower food & fuel prices. 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 Mar’24 rather than late 2023.
Subsequently, Nifty stumbled to some extent. Nifty also stumbled from the session high soon after RBI presser/Q&A on 8th June (policy date) as Governor Das clarified that the policy action must be seen as a temporary pause, not a pivot. RBI chooses to hold the repo rate 2nd 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 6th consecutive hike from May’22 to Apr’23.
After April, RBI again paused on 8th June as the market was almost sure about a pause by Fed on 14th June. 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 but did not pivot as RBI may want to see actual Fed rate action and SEP on 14th June and any guidance for the rest of the year (H2CY23).
Overall, the U.S. labor market and core inflation trajectory are still hot enough for another two Fed hikes. Fed never surprised the market with its rate action, and as the overall labor market and core inflation is cooling gradually, while the Fed repo rate at +5.25% is now near the mid-zone (+5.50%) of the restrictive zone (5.00-6.00%), Fed goes for a pause on 14th June, but also projected (June SEP) for another two hikes in H2CY23 to manage inflation expectations.
The U.S./Fed’s average underlying core inflation is now around +5.0% (CPI+PCE), and at +5.25% repo rate, the real rate is now positive by around +0.25% and just below the middle range of the Fed’s restrictive zone (5.00-6.00%). The May core inflation data came largely in line with market expectations just a day before Fed’s MPC date. But even if the May core inflation data unexpectedly surged, Fed may not alter its hold decision to shake the market just a day ahead of the MPC date.
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)*(6.00-2.00) =0+2+4.00=6.00%
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=6.00% (for 2022)
Looking ahead, Fed may consider a quarterly/3M rolling average of underlying core inflation and outlook. As Fed is trying to bring down core inflation towards +2.0% targets without causing an all-out recession (soft/softish landing), Fed may henceforth move only in every alternate meeting by +25 bps rather than in each consecutive meeting for a calibrated action after increasing the rate to restrictive zone-real positive.
Fed is slowing down from +75 bps to 50 bps and then 25 bps from every meeting to possibly every alternate meeting in H2CY23. Fed is trying to bring down core inflation towards +2.0% targets without causing an all-out recession (soft/softish landing). Thus in its June SEP (dot plots), Fed forecasted another 50 bps rate hike for H2CY23 to control market, bond yield, and also inflation expectations.
Looking ahead, Fed may try to balance the financial/Wall Street stability and price stability by expressing intentions to move for any rate action in July and November. Also, 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. has paid 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, ensuring a soft and safe landing.
India’s core CPI continues to be sticky around +6.00% since Jan’21 and consistently above +4.0% targets even before COVID. Like Fed, RBI is also far behind the inflation curve for a long. Thus RBI wants to ensure a real positive rate, by around +100 bps (restrictive levels), wrt at least average core inflation. RBI continued 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 a Central Bank, RBI’s job is to hike rates well into the restrictive zone to curtail demand so that it can match with currently constrained supply, resulting in lower inflation. RBI as-well-as Fed, has done their jobs almost fully and may hike once/twice more in H2CY23 and a long pause thereof at least till H1CY24 before any plan to cut (if core inflation indeed goes down towards target zones).
In the last financial year (FY23), RBI hiked the +250 bps repo rate, and core CPI declined -100 bps from around +7.0% to +6.0% on average; Indian 10Y bond yield also moved up around +100 bps from around +6.0% to 7.0%. At this run rate, if RBI goes for a pause around the 6.50-6.75% repo rate, the core CPI may further fall to around +5.0% by Mar’24 and +4.0% targets by Mar’25.
In India, a higher interest rate may not contain core inflation alone for various reasons, like the government’s indirect control over domestic fuel (petrol & diesel) as per political compulsion. In the last year, global crude oil prices tumbled from around $117 to $67, and India is buying a major portion of Russian oil significantly cheaper than the market price. But the Indian government has not allowed OMCs to reduce retail prices of petrol & diesel, apparently to ensure that OMCs remain profitable (after adjusting any previous losses). The government is also collecting huge tax revenue from fossil fuel, which is helping in deficit spending (led by infra spending). The Government may allow OMCs to reduce prices ahead of any major state election and also the early 2024 general election.
In any way, as the government has not passed the benefit of lower crude oil prices into the retail price of petrol & diesel, India’s core inflation remains elevated and sticky around +6.0% for most of 2022 and even early 2023. Also, in India, there is significant wage inflation for not only government employees (through DA) but also for private employees, especially corporates; i.e., the wage increase is higher than the productivity gain. This, in turn, is also resulting in higher goods and service prices, creating a cycle of higher inflation.
Also, India’s fiscal stimulus, i.e., deficit spending and grants by the government, is creating inflation directly/indirectly (through a systematic corruption route). India’s almost 30% population, equivalent to almost the U.S. population, may belong to the high middle class/rich category due to good salary income (often more than productivity levels), corruption /unaccounted money, vibrant capital/real estate market, and growing startups and digital ecosystem (You tubers). Most of these categories of the high middle-class population are rich in cash and generally don’t need to borrow heavily for consumption or investment.
Thus despite higher borrowing costs, overall consumer demand in India remains resilient, and so core inflation remains elevated and sticky around +6%, which is quite bad for the rest 70% of the population, which belongs to the lower-middle class or under APL/BPL. This 70% of the population also forms a formidable vote bank for any political party, and thus, any government, which is not able to manage inflation consistently, will be vulnerable in the next election (as seen in the recent Karnataka state election, where ruling party BJP/Modi had suffered the formidable loss despite their best campaign effort). The same is true for employment.
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) =0.50+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 (for CY22)
Thus assuring the estimated average core inflation is around +5.00% in CY23, the restrictive range of the RBI repo rate may be around 6.50-7.50%. If Fed continues to hike +50 bps in H2CY23 (even after June’23 pause) to +5.75% by Dec’23 (in case U.S. 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 6.75% in CY23 by hiking once in Dec’23 if Fed indeed goes for two hikes in July and November; otherwise, RBI may not hike further in 2023 (even if Fed goes for only one hike in July in H2CY23).
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. Thus RBI again reminded the market on the 6th April MPC statement about the real rate of interest of +4.50% in Feb’2019 (when RBI started the pre-COVID rate cut cycle to support economic growth); in Feb’2019, RBI repo rate was +6.50%, while headline CPI was around +2.00%, but core CPI was around +5.25%. Thus the actual real rate of interest about core CPI was around +2.25% in Feb’2019 against Rajan’ (former RBI Governor) preference of around +1.50% (1.00-2.00%).
Under Governor Das and Modi admin, RBI may prefer to keep the real rate of interest around 0.50-1.50%; as India’s core CPI is now averaging around +6.00%, RBI may keep the terminal rate between 6.50%-7.50% 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, RBI may keep the terminal repo rate around 6.50-6.75% if Fed does not go beyond +5.75% and India’s core CPI stays below +6.50%.
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, RBI is still open for another one/two calibrated +25 bps rate hikes. If Fed indeed goes for another two rate hikes 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%.
If Fed goes for only another rate hike in H2CY23 for a terminal repo rate of +5.50%, RBI may continue to hold at +6.50% in FY24. And if Fed does not hike more in H2CY23 and keep the terminal repo rate at present levels of +5.25%, then RBI may even go for a -25 bps rate cut in Apr’24, just ahead of India’s general election in May-June’24 to boost Dalal Street, economy, and risk on/feel-good sentiment.
Technical Analysis: Nifty Future (LTP: 18975)-EOD: 28/06/23
Looking ahead, whatever may be the narrative, technically, Nifty Future now has to sustain over 19100 for a further rally to 19200*/19300-19400/19750 in the coming days (Bullish side). On the flip side, sustaining below 19050-18875 Nifty future may again fall to 18700/18600*-18500/18275* and 18150/18100*-17925/17775 and 17550*/17300-17000/16800* and 16650* in the coming days (Bear case scenario).
Technical Analysis: USDINR Future (LTP: 81.50) - EOD: 28/06/23
Looking ahead, whatever may be the narrative, technically, USDINR Future now has to sustain over 81.50 for a rally to 82.00/82.50-83.00/83.30, and sustaining above 83.50, USDINR may scale 85.50-86.00 levels by Mar’24 (ahead of India’s general election)-Bullish case scenario.
On the flip side, sustaining below 81.25, USDINR may further fall to 80.90/80.40-79.10/78.70, and sustaining below 78.50 may further fall to 75.80-72.70 in the coming days-Bear case scenario.
USDINR Future: 81.00-83.00 is now a broad range
I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Stocx Research Club). I have no business relationship with any company whose stock is mentioned in this article.
ALL DATA FROM THE RESPECTIVE WEBSITE
I am not a SEBI Registered individual/entity and the above research article is only for educational purpose and is never intended as trading/investment advice.
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