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RBI may continue to hike at a 50 bps rate in line with Fed

Inflation may not come down meaningfully if Russian geopolitical tensions and economic sanctions linger

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On 8^th June, India’s RBI hiked key policy rates by +0.50% against median market expectations of +0.40% to control surging inflation. RBI hiked repo rate, effective reverse repo rate (SDF-Standing Deposit Facility), MSF (Marginal Standing Facility), and Bank rate-all by +0.50% to +4.90%, +4.65%, +5.15%, and +5.15% respectively. Although RBI hiked by +0.50% in June after a surprising hike of +0.40%  in May, this time RBI didn’t hike the CRR (Cash Reserve Ratio) as expected by some market participants.

On economic projections, RBI raised FY23 average CPI inflation to +6.7% from the prior estimate of +5.7%, while keeping the real GDP growth forecast unchanged at +7.2%. Overall, RBI/Governor Das was quite hawkish about both economic growth and hotter inflation. RBI primarily blamed external geopolitical tensions (Putin’s invasion of Ukraine) and subsequent economic sanctions for elevated global commodity prices (including oil & gas) and hotter inflation back home.

RBI/Das didn’t indicate any rate hike pause in forthcoming meetings. Despite various narratives, RBI has to follow Fed’s rate action to maintain the present level of policy differential. As Fed will hike by +0.50% in June and July, RBI hiked on 8^th June (ahead of Fed’s 15^th June) by +0.50% and may again hike by +0.50% in the next MPC meeting on 4^th August (against Fed’s 27^th July) and so on. As a reminder, RBI hiked abruptly on 4^th May in an unscheduled meeting by +0.40% barely 12-hours ahead of Fed’s much anticipated +0.50% rate hikes. At that time, Das said RBI is merely rolling back COVID era emergency rate cuts of +0.40% and +0.75%.

In May, Das said the war in Europe (Russia-Ukraine) has led to a ‘tectonic shift’ in the geopolitical and global economy. This time, Das pointed out the war has led to synchronized global inflation or rather a stagflation. And India is not an exception amid global supply chain disruption, elevated prices of global commodities, and persistent imbalance of demand and supply.

But Das was also very upbeat about the Indian growth story due to strong macros and buffers despite various global headwinds/challenges. Das pointed out various factors in favor of India’s strong economic growth despite hotter inflation. As per RBI, India’s FY23 economic growth will be around +7.2% -it will be supported by the full reopening of the contact-sensitive/consumer-facing service industry from COVID disruption, robust private and government capex, higher capacity utilization, solid export growth, and deleveraged corporate balance sheet as-well-as rock-solid banks & financials. Various high-frequency economic indicators are also showing solid economic growth

As per RBI, hotter inflation in India is primarily due to only supply shocks amid adverse geopolitical situations (Russia-Ukraine war) and not to any elevated demand factor. RBI sees higher inflation risk amid elevated global commodity prices including oil; revisions in domestic electricity tariffs across many states; high domestic poultry and animal feed costs; continuing global trade and supply chain bottlenecks; rising pass-through of input costs to selling prices in the manufacturing and services sectors (pricing power); and even the recent spike in tomato prices which are adding to food inflation.

Nevertheless, core inflation is becoming sticky as producers have adequate pricing power due to the stability of demand, even at higher prices. RBI hopes inflation cools down in the medium term amid tighter monetary policies; i.e. higher borrowing costs/lower liquidity and some supply-side/fiscal action by the fiscal authority (Government), like reduction of taxes on transportation fuel and lower tariffs (import duties) on edible oil.

In any way, irrespective of any supply-side action by the fiscal authority, RBI thinks economic growth is still robust, but if inflation is substantially higher than the 4% target, RBI will tighten monetary policy; i.e. hike rates to control demand and inflation/inflation expectations; otherwise inflation will jump more in the coming days.

RBI also indicated due to faster Fed tightening, DEs like India (RBI) has no option but to match Fed and tighten, (whatever may be the narrative); otherwise, outflow and currency depreciation will intensify. As a result of RBI tightening in April (reverse repo hike through SDF) and May (repo rate hike), systemic liquidity has moderated recently and surplus liquidity in the banking system/money market reduced to Rs.5.5T from Rs.7.5T. This has resulted in an overall tightening of financial conditions. Looking ahead, RBI will ensure adequate liquidity support for the productive sector of the economy and also for the government borrowing program.

USD has appreciated significantly in recent times due to faster Fed tightening and lingering geopolitical tensions (safe-haven appeal), especially wrt to EM currencies amid portfolio outflows. But despite that INR is stable and moving in an orderly manner-only depreciating around -2.5% in this FY (till May). This may be due to the huge USD reserve of India/RBI to the tune of over $600B. Also, the overall trade deficit/balance of trade/CAD is manageable amid normal capital inflows and robust remittance.

The CAD impact of rising crude oil prices on petroleum, oil, and lubricants (POL) import bill has been partly offset by rising export of petroleum products, which also benefitted from better price realizations (GRM) in recent months. Indian oil refiners, such as RIL are now exporting higher diesel/transportation fuel to Europe amid a boycott/ban of Russian oil/refinery products. India is also buying Russian oil at a huge discount and various private/public refineries are making windfall gains with higher export to Europe. RBI also allowed a higher limit for personal housing loans by both Urban and Rural Cooperative banks along with new permission to extend loans for commercial real estate.

Finally, in line with recent Fed/Powell comments, RBI/ governor Das also acknowledged maintaining price stability is the best way to ensure sustainable economic growth as RBI now shifting its focus from growth to inflation. RBI is now trying to bring down inflation from around 8% to the 4% target. But at the same time, RBI is projecting economic/real GDP growth over +7%; i.e. like Fed, RBI is also assuring a soft landing rather than a hard landing despite faster/bigger tightening.

RBI Governor’s Statement: 8^th June’2022

In my statement of May 4, 2022, I mentioned that as we navigate through this difficult period, it is necessary to be sensitive to the new realities and incorporate them into our thinking. The war in Europe is lingering and we are facing newer challenges each passing day which is accentuating the existing supply chain disruptions. As a result, food, energy, and commodity prices remain elevated. Countries across the world are facing inflation at decadal highs and persistent demand-supply imbalances.

The war has led to the globalization of inflation. Not surprisingly, central banks are reorienting and recalibrating their monetary policies. Emerging market economies (EMEs) are facing bigger challenges from increased market turbulence, monetary policy shifts in advanced economies (AEs), and their spillovers. The process of economic recovery in EMEs is also getting affected.

During these difficult and challenging times, the Indian economy has remained resilient, supported by strong macroeconomic fundamentals and buffers. The recovery has gained momentum despite the pandemic and the war. On the other hand, inflation has steeply increased much beyond the upper tolerance level. A large part of the rise in inflation is primarily attributed to a series of supply shocks linked to the war. In these circumstances, we have started a gradual and orderly withdrawal of extraordinary accommodations instituted during the pandemic.

Similar to our resolute and timely actions to limit the economic damage emanating from the COVID-19 pandemic, the Reserve Bank will continue to be proactive and decisive in mitigating the fallout of the ongoing geopolitical crisis on our economy. We have already reprioritized our policies to control inflation, without losing sight of the growth requirements. Our approach underscores a commitment to move towards normal monetary conditions in a calibrated manner. We will remain focused on bringing down inflation closer to the target and fostering macroeconomic stability.

Decisions and Deliberations of the Monetary Policy Committee

Against this background, the Monetary Policy Committee (MPC) met on the 6th, 7th, and 8th of June 2022. Based on an assessment of the macroeconomic situation and the outlook, the MPC voted unanimously to increase the policy repo rate by 50 basis points to 4.90 percent, with immediate effect. Consequently, the standing deposit facility (SDF) rate stands adjusted to 4.65 percent; the marginal standing facility (MSF) rate, and the Bank Rate to 5.15 percent. The MPC also decided unanimously to remain focused on the withdrawal of accommodation to ensure that inflation remains within the target going forward while supporting growth.

Let me now explain the MPC’s rationale for its decisions on the policy rate and the stance. The protracted war in Europe and the accompanying sanctions have kept global commodity prices elevated across the board. This is exerting sustained upward pressure on consumer price inflation, well beyond the targets in many economies. The ongoing war is also turning out to be a dampener for global trade and growth. The faster pace of monetary policy normalization undertaken by systemic advanced economies (AEs) is leading to heightened volatility in global financial markets.

This is reflected in sharp corrections in major equity markets, sizeable swings in sovereign bond yields, US dollar appreciation, and capital outflows from EMEs and even from some AEs. The EMEs are also witnessing the depreciation of their currencies. Globally, stagflation concerns are growing and are amplifying the volatility in global financial markets. This is feeding back into the real economy and further clouding the outlook.

The MPC noted that, in such a challenging global environment, domestic economic activity is gaining traction, while inflation pressures have intensified further. The upside risks to inflation as highlighted in the April and May 2022 policies have materialized earlier than anticipated – both in terms of timing and magnitude. Inflationary pressures have become broad-based and remain largely driven by adverse supply shocks. There are growing signs of a higher pass-through of input costs to selling prices. The MPC noted that inflation is likely to remain above the upper tolerance band of 6 percent through the first three quarters of 2022-23.

In this context, supply-side measures taken by the government in reducing excise duties on petrol and diesel, along with the other measures would help in mitigating the inflationary pressures to some extent. The MPC also recognized that sustained high inflation could unhinge inflation expectations and trigger second-round effects. It, therefore, judged that further monetary policy measures are necessary to anchor the inflation expectations.

Accordingly, the MPC decided to increase the policy repo rate by 50 basis points to 4.90 percent. The MPC also decided to remain focused on the withdrawal of accommodation to ensure that inflation remains within the target going forward while supporting growth. It may be noted in this context that the repo rate remains below its pre-pandemic level.

Assessment of Growth and Inflation

Growth

According to the provisional estimates released by the National Statistical Office (NSO) on May 31, 2022, India’s real gross domestic product (GDP) growth in 2021-22 is estimated at 8.7 percent. The level of real GDP in 2021-22 has exceeded the pre-pandemic (2019-20) level. On the supply side, major categories also surpassed the 2019-20 levels.

Available information for April and May 2022 indicates that the recovery in domestic economic activity remains firm, with growth impulses getting increasingly broad-based. Manufacturing and services purchasing managers’ indices (PMIs) for May point towards further expansion of activity. This is also corroborated by movements in railway freight and port traffic, domestic air traffic, GST collections, steel consumption, cement production, and bank credit.

While urban demand is recovering, rural demand is gradually improving. The contact-intensive services related to trade, hotels, and transport have recovered in Q4:2021-22.

Going by the early results of our surveys, capacity utilization (CU) in the manufacturing sector increased further to 74.5 percent in Q4:2021-22 from 72.4 percent in Q3:2021-22. Capacity utilization is also likely to increase further in 2022-23. Investment activity is thus expected to strengthen, driven by rising capacity utilization, the government’s capex push, and deleveraged corporate balance sheets. Improvement in investment activity is also reflected in a pick-up in demand for bank credit and persisting growth in imports of capital goods. Merchandise exports have remained buoyant with double-digit growth for the fifteenth successive month in May, while the high growth of non-oil non-gold imports is indicative of a recovery in domestic demand conditions.

Looking ahead, real GDP is expected to broadly evolve along the lines of the April 2022 MPC resolution. The forecast of a normal southwest monsoon should boost Kharif sowing and agricultural output. This will support rural consumption. The rebound in contact-intensive services is expected to sustain urban consumption. Our surveys suggest further improvement in consumer confidence and households’ optimism for the outlook a year ahead. Business sentiment remains upbeat according to early results of our surveys. Nevertheless, the negative spillovers from geopolitical tensions; elevated international commodity prices; rising input costs; tightening of global financial conditions; and a slowdown in the world economy continue to weigh on the outlook.

Taking all these factors into consideration, the real GDP growth for 2022-23 is retained at 7.2 percent, with Q1 at 16.2 percent; Q2 at 6.2 percent; Q3 at 4.1 percent; and Q4 at 4.0 percent, with risks broadly balanced.

Inflation

The CPI headline inflation in April registered a further sharp increase to 7.8 percent. It was the fourth consecutive month when inflation touched or was above the upper tolerance level of 6 percent. The surge in headline inflation was seen across all major categories.

The global geopolitical situation remains fluid and commodity markets remain on the edge, rendering heightened uncertainty to the domestic inflation outlook. Certain positive developments on the prices front in recent weeks may help to ease the acute price pressures to some extent. These would include expectations of a normal south-west monsoon and Kharif agricultural season; the recent supply-side measures taken by the government and the unfolding of their impact; lifting of the palm oil export ban by Indonesia; and signs of moderation in global industrial metal price indices.

Our quick survey of urban households undertaken after the excise duty cuts on petrol and diesel on May 21, 2022, shows a significant moderation in their inflation expectations: declines of 190 basis points in their three months ahead of expectations and 90 basis points one year ahead of expectations. In such a scenario, further reduction of State VATs on petrol and diesel across the country can certainly contribute to softening of the inflationary pressures as well as expectations.

Notwithstanding these positive developments, upside risks to inflation do persist. These risks emanate from elevated commodity prices; revisions in electricity tariffs across many states; high domestic poultry and animal feed costs; continuing trade and supply chain bottlenecks; rising pass-through of input costs to selling prices in the manufacturing and services sectors; the recent spike in tomato prices which are adding to food inflation; and most important of all, the elevated international crude oil prices.

With the assumption of a normal monsoon in 2022 and an average crude oil price (Indian basket) of US$ 105 per barrel, inflation is now projected at 6.7 percent in 2022-23, with Q1 at 7.5 percent; Q2 at 7.4 percent; Q3 at 6.2 percent; and Q4 at 5.8 percent, with risks evenly balanced. It may be noted that around 75 percent of the increase in inflation projections can be attributed to the food group. Further, the baseline inflation projection of 6.7 percent for 2022-23 does not take into account the impact of monetary policy actions taken today.

Between February and April, headline inflation has increased by about 170 basis points. With no resolution of the war in sight and the upside risks to inflation, prudent monetary policy measures would ensure that the second-round effects of supply-side shocks on the economy are contained and long-term inflation expectations remain firmly anchored and inflation gradually aligns close to the target. The monetary policy actions including withdrawal of accommodation will be calibrated keeping in mind the requirements of the ongoing economic recovery.

Liquidity and Financial Market Guidance

I would now like to touch upon liquidity and financial market conditions. It may be recalled that in April we introduced the Standing Deposit Facility (SDF) as the floor of the liquidity adjustment facility (LAF) corridor at an interest rate of 3.75 percent. This was effectively a rate hike of 40 basis points over the fixed-rate reverse repo of 3.35 percent. As a result, the weighted average call money rate (WACR) – the operating target of monetary policy – moved from an average of 3.32 percent in March 2022 to 3.54 percent during April 8-30. Following the repo rate hike of 40 bps on May 4, the WACR has further increased, averaging 4.07 percent during May 5-31.

In line with the emphasis on the gradual withdrawal of accommodation articulated in the April and May MPC resolutions, systemic liquidity has moderated in the recent period. Surplus liquidity, as reflected in average daily absorption under the liquidity adjustment facility (LAF) – that is, the absorption under SDF and variable rate reverse repo (VRRR) of 14 days and 28 days – at ₹5.5 lakh crore during May 4-May 31 was lower than ₹7.4 lakh crore during April 8-May 3, 2022.

Nevertheless, the overhang of excess liquidity has resulted in overnight money market rates, on average, trading below the policy repo rate. At the longer end of the money market term structure, interest rates on 91-day treasury bills, commercial papers (CPs) and certificates of deposit (CDs) firmed up post the rate hike in May. Yields on AAA-rated 5-year corporate bonds have also increased. The rate hike also triggered an upward adjustment in the benchmark lending rates by banks. The term deposit rates of banks have increased and will augment stable funding resources amidst increasing credit demand.

Going ahead, while normalizing the pandemic-related extraordinary liquidity accommodation over a multi-year time frame, the Reserve bank will ensure the availability of adequate liquidity to meet the productive requirements of the economy. The Reserve Bank will also remain focused on the orderly completion of the government’s borrowing program.

A direct fallout of the geopolitical tensions and the rapid pace of policy normalization by AEs is the exodus of portfolio capital flows from most of the EMEs. Several EME currencies have thus faced depreciation pressures. Safe haven demand for the US dollar has increased. Amidst all these, the Indian Rupee has moved in an orderly fashion and has depreciated by 2.5 percent against the US dollar during the current financial year so far – faring much better than many of its EME peers.

The Indian banking system also remains strong and its health has improved in recent years as reflected in key indicators – capital adequacy, asset quality, provisioning coverage, and profitability. Bank credit offtake has gradually improved in the recent months, supported by both resilience of the banking system and progressive normalization of economic activity. The strength of the banking sector and deleveraged corporate balance sheets will help us in sustaining the economic recovery.

External Sector

India’s exports have performed exceptionally well despite a weakening recovery across major trading partners. The impact of rising crude oil prices on petroleum, oil, and lubricants (POL) import bill has been partly offset by the export of petroleum products, which also benefitted from better price realizations in recent months. Optimism on exports of both goods and services and remittances should help contain the current account deficit (CAD) at a sustainable level, which can be financed by normal capital flows. As of June 3, 2022, India’s foreign exchange reserves were of the order of US$ 601.1 billion, which are further supplemented by a healthy level of net forward assets of the RBI.

Additional Measures

I shall now announce certain additional measures, the details of which are set out in the statement on developmental and regulatory policies (Part-B) of the Monetary Policy Statement. The additional measures are as follows.

Regulatory Measures – Cooperative banks

Considering the importance of cooperative banks in promoting inclusive growth, three measures are being announced for the cooperative banking sector:

The limits for individual housing loans being extended by Urban Cooperative Banks (UCBs) and Rural Cooperative Banks (RCBs- State Cooperative Banks and District Central Cooperative Banks) which were last fixed in 2011 and 2009 respectively are being revised upwards by over 100 percent taking into account increase in house prices. This will facilitate a better flow of credit to the housing sector.

In line with the dispensation available to Scheduled Commercial Banks (SCBs) and UCBs, it is now proposed to permit Rural Cooperative Banks (RCBs- State Cooperative Banks and District Central Cooperative Banks) to extend finance to ‘commercial real estate – residential housing’ (i.e. loans for residential housing projects), within the existing aggregate housing finance limit of 5% of their total assets. This measure will further augment credit flows from the cooperative banks to the housing sector. It has also been decided to permit UCBs to extend doorstep banking services to their customers. This will enable UCBs to meet the needs of their customers, especially senior citizens and differently-abled.

Margin Requirements for Non-Centrally Cleared Derivatives (NCCDs)

With the objective of strengthening the resilience of OTC derivative market and in line with G20 reforms, the Reserve Bank is putting in place margin requirements for non-centrally cleared OTC derivatives. In the first phase, the Directions on the Exchange of Variation Margin (VM) for NCCDs were issued on June 1, 2022, after consultation with stakeholders. In the second phase, it is now proposed to mandate the requirements for exchange of Initial Margin (IM) for such derivatives. To garner feedback from stakeholders on these requirements, Draft Directions on Exchange of Initial Margin for NCCDs will be issued shortly.

e-Mandates on Cards for Recurring Payments – Limit Enhancement

The framework for processing of e-mandate-based recurring payments was introduced by the Reserve Bank, keeping in mind the benefits of convenience, safety, and security to the users. Under this framework, over 6.25 crore mandates have been registered in favor of a large number of domestic and over 3,400 international merchants. To further facilitate recurring payments like subscriptions, insurance premia, education fees, etc. of larger value under the framework, the limit is being enhanced from ₹5,000 to ₹15,000 per transaction. This will further leverage the benefits available under the framework and augment customer convenience.

Unified Payments Interface (UPI) – Linking of RuPay Credit Cards

UPI has become the most inclusive mode of payment in India with over 26 crore unique users and 5 crore merchants on the platform. In May 2022 alone, about 594 crore transactions amounting to ₹10.4 lakh crore were processed through UPI. At present, UPI facilitates transactions by linking savings/current accounts through users’ debit cards. It is now proposed to allow the linking of credit cards on the UPI platform. To begin with, the Rupay credit cards will be linked to the UPI platform. This will provide additional convenience to users and enhance the scope of digital payments.

Review of Payments Infrastructure Development Fund Scheme

The Payments Infrastructure Development Fund (PIDF) Scheme was operationalized by the Reserve Bank in January 2021 to incentivize the deployment of payment acceptance infrastructure such as physical Point of Sale (PoS), mPoS (mobile PoS), Quick Response (QR) codes in Tier-3 to 6 centres and North Eastern States. Beneficiaries of PM SVANidhi Scheme in Tier-1 and 2 centres were included in August 2021. As at end-April 2022, over 1.18 crore new touch points have been deployed under the Scheme against a target of 90 lakh touch points to be deployed over three years (till end-2023). It is now proposed to make modifications to the PIDF scheme by enhancing the subsidy amount, simplifying the subsidy claim process, and other steps. This will further accelerate and augment the deployment of payment acceptance infrastructure in the targeted geographies.

Concluding Remarks

Experience teaches us that preserving price stability is the best guarantee to ensure lasting growth and prosperity. Our actions today will impart further credibility to our medium-term inflation target, which is the central tenet of a flexible inflation targeting framework. India’s recovery is proceeding apace, offering us space for an orderly policy shift. While we will continuously assess the evolving situation to tailor our responses, our actions must demonstrate the commitment to keep inflation and inflationary expectations under check. Therefore, monitoring and assessing inflation pressures and balancing risks to growth will be crucial for judging the appropriate policy path as we move ahead.

The road we have traveled in the recent past has indeed been very arduous, but we gathered faith, focus, and fortitude along the way. Our actions today are in continuation of several measures that have been taken recently to achieve price stability. Given the elevated uncertainties of the current period, we have remained dynamic and pragmatic rather than being bound by stereotypes and conventions. As the Reserve Bank works tirelessly in its pursuit of macro-financial stability, I am reminded of what Mahatma Gandhi said long ago: “If we want to overtake the storm that is about to burst, we must make the boldest effort to sail full steam ahead”.

On 8^th June, post-policy presser, RBI Governor Das said in his opening remarks:

It's not an address; it is just a few opening remarks which I wish to make. I had made a similar set of remarks in the April Monetary Policy when we had met last. Now, I would like to just touch upon some of the main highlights of today's monetary policy.

First, we have retained the growth projection for the current year at 7.2 percent. Second, on inflation, we have revised our projection and we are now projecting 6.7 percent for the full year 2022-23. Within that, there are three or four points that need to be noticed.

The first is that 75 percent of this increase in our inflation projection, compared to what we had made in April, is attributed to food inflation; this is something that I had said in my statement also. By and large, if you look at it accepting factors like the tomato prices slightly going up or some domestic electricity tariffs being revised by the states, primarily the food inflation spike is linked to external factors, namely, the war in Europe. That is the first point under inflation.

Second is what we have given out is the baseline scenario, without factoring in the steps that we have taken today.

Third, we believe that our actions will have an impact on bringing down inflation and inflation expectations. We remain committed to bringing down inflation and inflation expectations.

Fourth, our rate action and other actions are calibrated to the evolving inflation-growth dynamics. Inflation must come down. Economic recovery also must continue.

So, I talked about growth, I talked about inflation; these are two points.

The third point I would like to mention about the rate hike and the stance. The rate hike is obviously no brainer, it is 50 basis points. So, the repo rate now stands at 4.9 percent. We have said that clearly. As regards the stance, as you would have noticed, we have dropped the word, ‘we remain accommodative’, that is mainly to give greater clarity to the market. We are now focusing on the withdrawal of accommodation. What does that mean? It means that we are now completely focused on the withdrawal of accommodation.

But in terms of rates, we are still below the pre-pandemic level in terms of liquidity. The liquidity surplus in the market is still higher than the pre-pandemic level. In that sense, the stance remains accommodative. But we are now completely focused on the withdrawal of accommodation, and this gives greater clarity to the market and to all the stakeholders and to all of you who are analyzing and writing about it.

The fourth point is with regard to liquidity. There was a lot of speculation around CRR. We have not increased the CRR. The liquidity withdrawal, going forward, will be calibrated and measured. We will ensure that adequate liquidity is available to meet the productive requirements; to meet the credit requirements of the economy, i.e., the bank credit requirements.

Fifth and final, as I have very clearly mentioned in my statement, the Reserve Bank is not bound by any stereotypes and conventions. The Reserve Bank will continue to be dynamic and pragmatic in its approach.

I'll stop here and we will now take the questions.

Highlights of comments by RBI Governor Das in the Q&A session post-policy meeting: 8^th June’2022

·         The future course of rate hikes will depend upon evolving inflation-growth dynamics

 

“As I just mentioned and as I have said in my statement that our future action will depend on the evolving inflation growth dynamics. The situation is fast-changing and it will depend on how the situation evolves.”

 

·         RBI is not in a position for any forward guidance on rates despite inflation being substantially above target; there is a very uncertain global outlook; RBI is constantly watching the evolving situation and will act accordingly

 

“It’s an extremely uncertain conditions that we have, and in the context of an extremely uncertain outlook, it is not possible to provide forward guidance on what you are mentioning, it will depend on how the situation evolves. With regard to what you are calling, it will be breaching the inflation target framework, etc., we will deal with it as and when the situation arises. The situation is very dynamic so, I would not like to speculate anything on that. The law is very clear, and we will do accordingly. As it stands today, I would not like to speculate that this will happen and then we will do this. Internally, we examine all possibilities in various directions under various scenarios. As I said, I'm repeating again that it will depend on the evolving situation---- There is a stance. I have said in my statement also and our stance is withdrawal of accommodation.”

 

·         By normal/neutral rate, RBI means overnight call money market rates are more or less aligned with policy repo rate; presently it’s more aligned with effective reverse repo (SDF) rate and much below repo rate. Thus RBI will primarily target WACR (Weighted Average Call Money Rate), which moved from an average of +3.32% to +3.54% after the hike of the effective reverse repo (SDF) rate by +0.40% in April and then further increased to an average of +4.07% during May 5-31 after the repo rate hike +0.40% on 4^th May in an unscheduled meeting. The WACR will move further up closer to the repo rate as per the RBI target if RBI absorbs higher liquidity from the money market and simultaneously hikes the repo rate

 

“The way I look at normal, I and my colleagues in RBI, and the way RBI looks at normal conditions, and so is the MPC, is that if you recall the February 2020 monetary policy framework which we announced, it is linked to the overnight rates. The critical factor will be not the quantum of liquidity or not any particular level. We have not speculated or we have not said that this is the normal rate; normal rate meaning the policy rate. All that we have said is that when the overnight rates are in alignment with the repo rate. Even currently the overnight rates are below the repo rate. They are closer to the SDF rate. So, normal condition would primarily mean, when the overnight call money market rates are more or less aligned with the policy repo rate.”

 

·         By real rate, RBI inflation reference would be either Q4FY23 or Q1FY24 inflation projections

 

“The real rate is always forward-looking, just like the rest of monetary policies. So, you should consider the forecast of the inflation rate sometime into the future, within which monetary policy works and then calculate the real rate--- you have the Q4 number, and from the Monetary Policy Report, you have the 2023-24 numbers. As Governor mentioned you will have to feel your way, it’s a very dynamic situation. We will have to see how the future evolves.”

 

·         RBI is withdrawing additional system liquidity in a calibrated manner since last year when it abruptly stops G-SAP (QE) even before the Fed acted. Then RBI introduced VRRR, which is still operating to absorb liquidity. RBI also hiked the CRR rate to absorb liquidity. But RBI can’t commit any particular time frame (like FY23) by which it will be neutral as per as liquidity is concerned; presently the liquidity is still accommodative; i.e. excess

 

“What multiyear time cycle basically means is that we started withdrawal of liquidity even last year. We stopped the G-SAPs. In other words, we did not announce new G-SAPs. We also introduced the VRRRs last year, the Variable Rate Reverse Repo auctions. This year we have taken steps. Again, the VRRRs are being continued. In the May policy statement, we increased the CRR also.

 

A multiyear would basically mean, as I have said earlier, a 2–3 year cycle. So, when you say 2-3 year, again it is very flexible. The situation is very dynamic. It can be argued that we started last year, so last year is year 1, this year is year 2, next year is year 3; but in these extremely uncertain conditions, all that we are trying to convey is that it is not as if we are doing it suddenly, abruptly, in a compressed manner during the current financial year.

 

All that we wanted to convey is that we don’t want to take any sort of abrupt, rushed action which may sort of be detrimental to the system, to the market or to the credit offtake.”

 

·         RBI’s rate hike actions may show a result (lower inflation) after 6-8 months; RBI will watch evolving economic situation and will update about FY24 inflation estimates in its October monetary policy report

 

“You see each action takes its time to play out. Monetary policy actions would take ideally 6 to 8 months to fully play out. We will watch the evolving situation and next year’s inflation numbers are given in Monetary Policy Report. The next report is due in October. So, we will give it at that time.”

·         RBI’s aspirational target for inflation is closer to +4.0% (in a symmetric way), not +6.0%. RBI does not want to go for a liquidity deficit situation for various factors, but theoretically, in such a hypothetical situation, one can always tap the RBI repo window for funds

 

“We have said that our endeavor will be to move closer to the target. And the target is 4.0 percent plus or minus 2.0 percent on either side. So, that target of 4.0 percent does remain.

 

Liquidity is impacted by so many other factors. The pace of government expenditure, frontloaded capital expenditure, for example by the government as it happened last year, if this year also the capital expenditure and other expenditure are frontloaded, it adds to the liquidity. Credit offtake which has now, we have mentioned it in the resolution, improved. The increase is by 12.0 percent. If this increase is sustained, then obviously liquidity goes out of the system.

 

There are other factors also relating to the foreign exchange market, which add or drain out liquidity. It is a constantly evolving situation. All that we are saying is that we will ensure the availability of adequate liquidity. If the liquidity runs into a very heavy deficit, that is your question, then the repo window is always available, that can be used by the system.”

 

·         RBI is unable to give any forward guidance due to extremely volatile and uncertain geopolitical situations (RBI constantly watching Fed), but RBI will ensure a smooth government borrowing program

 

“In extremely volatile and uncertain conditions, we just cannot give any forward guidance. We are constantly watchful. In fact, on a real-time basis, the entire team in the Reserve Bank is watching and we will be taking action. If you recall while reading out my statement, I took a pause, when I was talking about implementing the government borrowing program, in the current year in a non-disruptive manner. I took a pause and I explained that I have not said what steps will be taken by the RBI, but as per the evolving situation, as per the requirement we will be using various instruments which are available to us.”

 

·         RBI will ensure orderly evolution of the bond yield curve for the lowest possible borrowing costs for the government; i.e. RBI will be in a targeted YCC mode without launching QE as RBI has various other instruments like Operation Twist or RBI will innovate something new for an effective YCC

 

“Preferred step will depend on where we stand. Let me say that we are monitoring the G-sec markets; in fact we monitor all markets. G-sec market also, we are monitoring it very closely. Preferred step will again depend on the situation prevailing at that time. You know what instruments are available with us. With regard to Operation Twist, we have today greater leverage, greater flexibility because we have enough securities. Because of introduction of SDF, naturally the securities which are available to us, which in an otherwise, in previous context if there was a reverse repo, we have to give out securities.

 

Today we have enough securities to undertake Operation Twist. This is just a factual information; I am not giving a forward guidance. But what I am saying is that we have greater leverage today with regard to Operation Twist and we have other instruments at our command. If our team in RBI comes out with any innovative steps to deal with the liquidity problem, then we will see. But, at the moment, there are no innovative steps, so don’t jump into any conclusion that another G-SAP or something like that. All that I am wanting to say is that we are watchful and we will take necessary steps as maybe required.”

 

·         RBI sees rate hike effects on both lending and savings rates for proper transmission of Monterey policy tightening and lower inflation

 

“We have instituted this external benchmarking for two years now, in October 2019. We are monitoring it and normally the transmission does take time. We just announced the rate hike roughly one month ago. The transmission takes about 1-3 months, it will take time. But, going forward, we do expect the rate hikes to get transmitted also to the liability side, namely to the deposit rates. I have acknowledged that in my statement also that the bank deposit rates have started going up. In any case, when there is a credit offtake, banks need to mobilize more resources by way of offering higher deposit rates to the savers.”

 

·         The Indian banking system is robust

 

“We do not discuss individual banks and the conditions prevailing in individual banks, outside and particularly not in a press conference. So, I will not comment on any individual bank. But as I have said in my statement, the Indian banking system remains resilient and strong in terms of various critical parameters like, capital adequacy, provisioning, profitability, and non-performing assets. Our supervision has been significantly deepened over the last three years. Each and every bank in our banking system is monitored very closely. We have the real-time data available with us, and we are monitoring it. Our supervisory officers are monitoring the situation in every bank very-very closely. Overall, the Indian banking system remains resilient and strong.”

 

·         RBI is confident that government will take more supply-side actions to control inflation as per requirement/evolving situation; there is no need for RBI to make any comments/suggestions about this issue

 

“--about the supply side measures--- Now it's for the government to take a call and I am sure government is mindful of the current inflation situation and it's for the government to decide on further supply-side measures, which they consider as necessary. On that, I would not like to speculate, or I would not like to comment on that. It is for government to decide, and I am sure they will decide if and when there is a requirement, they will take the steps.”

·         RBI is ahead of the inflation curve, not behind as the central bank hiked 130 bps (including reverse repo) in FY22 against 80 bps upper move in CPI; RBI will continue ‘working’ tightening till CPI is at +4.0% target of near it

 

“Actually, to correct you 130 basis points have been done during this year while inflation has moved up by only 80 basis points. I just answered the question in facts---Actually, I forgot to tell you, you should also take 20 basis points done last year by rebalancing from fixed to reverse repo too and we will continue working till inflation is at target or aligned to it----Never ask a Central Bank about the course of future interest rates.”

 

·         Despite recent tectonic shift/earthquake/super hurricane happing with the global economy amid Russia-Ukraine/NATO geopolitical tensions and economic sanctions, the Indian economy is quite resilient and strong due to robust macroeconomic factors and a strong banking system

 

“In that sense, RBI is ahead of all others. In the April Monetary Policy, I had used the word ‘tectonic shifts’, thereafter, the IMF used the word earthquake. Now you are referring to somebody referring to the hurricane, somebody referring to another, super bad feeling.

 

But the Indian economy has remained resilient. Indian economy is well-placed to deal with the challenges emanating from the geopolitical developments. The banking sector remains resilient and strong. Overall macroeconomic numbers also broadly look all right. Regarding the exchange rates depreciation so far, the Indian rupee is among the better-performing currencies among the comparable EME peers and others. The fiscal deficit number which was there in the budget for the last year that also has been achieved. Whatever was the target, it has improved, in fact. They had projected 6.9 percent and the fiscal deficit number is 6.7 percent.

 

So, overall Indian economy continues to be in a resilient position. The recovery is gaining traction and it is reflected in the fact that capacity utilization has improved as I have mentioned in my statement. Disbursal of bank credit is also picking up; rural demand and urban demand are also showing signs of further improvement. So that is how we stand.”

Conclusions:

RBI will follow Fed’s rate action to maintain the policy, bond yield, and FX rate differential; otherwise, FPIs may exit further. Fed has already confirmed about +0.50% rate hikes in July and after a hotter than expected reading of May inflation, Fed may continue to hike by +0.50% also in September, November, and December instead of earlier assumed +0.25%. There was also a buzz that the Fed may pause in September (ahead of the Nov’22 mid-term election) to assess +1.75% rate hikes till July.

Fed has already prepared the market for a neutral rate between 2.75-3.50% by Dec’22 along with QT (balance sheet reduction) @95B/M (a mix of passive and active QT) to control uncontrolled inflation, which is now becoming a major economic and political issue in the U.S. And Fed will hike @0.50% in each meeting of June, and July to reach +2.00% rates from present +1.00%.

Then depending upon the actual geopolitical, economic situation, and inflation/inflation expectations reading, Fed may hike either @0.25% or @0.50% in September, November, and December meeting for the neutral rate of +2.75% or +3.50% by Dec’22. If the actual inflation rate (monthly core PCE) deaccelerates towards the Fed’s goal of around +0.17% from the current average sequential rate of around +0.42% by Aug’22, Fed may slow down the rate of hikes in the latter part of the year from +0.50% to +0.25%; else it will go on with +0.50% rate hikes to reach +3.50% by Dec’22.

On Monday, there was a report that German Chancellor Scholz, French President Macron, and Italian PM Draghi are going to Ukraine on 16^th June to persuade Ukraine's Prez to accept the Italian peace proposal, supported by the U.S. If there is any peace agreement between Russia and Ukraine and subsequent rollback of various economic sanctions on Russia, then commodities including oil will come down and also inflation. Until then, inflation may not come down in a hurry. Thus Fed/global tightening pace will now largely depend on the Russia-Ukraine war trajectory.

Now from global to local, India’s RBI has to follow Fed’s policy action (rate hikes), whatever may be the rhetoric. Although RBI said it does not follow any rule book, in reality, it has to follow the Fed rule book; otherwise, USDINR will appreciate unorderly and there will be unusual outflows. Angel investors will invest in Bidenomics story rather than Modinomics, if RBI fails to keep real bond yield differential (FX risk-adjusted) not attractive enough wrt to US yields.

In India, RBI usually does not actively jawbone/telegraph the market about any possible policy rate action, unlike its U.S. counterpart Fed. RBI may be the only major global central bank in G20, which goes for any drastic change in policy action without any telegraph or attempt to prepare the market well in advance. But now, RBI is also gradually changing its strategy/age-old mentality/conventions. RBI Governor Das is now taking active participation in interviews a few weeks ahead of the MPC meeting.

Bottom line:

 

Depending on the trajectory of the Russia-Ukraine war and inflation, and Fed rate action, RBI may also hike +0.50% in August. And if the proxy war between Russia-NATO/U.S. lingers, then Fed, as well as RBI, may continue to hike @0.50% in subsequent meetings. But if there is a definitive peace agreement between Russia and Ukraine and a rollback of economic/other sanctions on Russia by July, the Fed may also take a pause in September to assess evolving economic situation and RBI will also follow Fed, whatever may be the narrative.

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