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RBI may continue to hike by another 160 bps through June’23

RBI may like to keep the repo rate at +7.50% against average core inflation around +6.00% and a probable Fed rate of +5.50%

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On 30^th September, Nifty made a recent low of 16747.70 in the opening session (before RBI) but soon recovered after RBI hiked +0.50% with a hawkish tone, providing support to INR. Indian market got a boost despite faster monetary tightening as RBI is now following the Fed. RBI hiked +0.50% on 30^th September against Fed’s +0.75% on 21^st September. This is protecting INR from an abrupt fall and boosts FPI's confidence. INR is not a fully convertible currency. This factor along with limited CAD/BOP (deficit) after considering buoyant service export, remittances, FDIs, and negligible external loan, India has stable macro, unlike many comparable EMEs.

Angel investors are looking for political/policy/macro/currency stability and the Indian market is enjoying a scarcity premium among EMEs due to these stabilities. Also the appeal of 5D (democracy, demand, demography, deregulation, and digitalization) and the mantra of reform and performance- the Indian market is now a favorite destination for FPIs. As highly expected, India’s central bank RBI hiked all policy rates by +0.50% on 30^th September.

Monetary Policy Statement, 2022-23 Resolution of the Monetary Policy Committee (MPC) September 28-30, 2022

On the basis of an assessment of the current and evolving macroeconomic situation, the Monetary Policy Committee (MPC) at its meeting today (September 30, 2022) decided to:

Increase the policy repo rate under the liquidity adjustment facility (LAF) by 50 basis points to 5.90 percent with immediate effect. Consequently, the standing deposit facility (SDF) rate stands adjusted to 5.65 percent, and the marginal standing facility (MSF) rate and the Bank Rate to 6.15 percent.

The MPC also decided to remain focused on the withdrawal of accommodation to ensure that inflation remains within the target going forward while supporting growth. These decisions are in consonance with the objective of achieving the medium-term target for consumer price index (CPI) inflation of 4 percent within a band of +/- 2 percent while supporting growth.

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

Assessment

Global Economy

Global economic activity is weakening under the impact of the protracted conflict in Ukraine and aggressive monetary policy actions and stances across the world. As financial conditions tighten, global financial markets are experiencing surges of volatility, with sporadic sell-offs in equity and bond markets, and the US dollar strengthening to a 20-year high. Emerging market economies (EMEs) are facing intensified pressures from retrenchment of portfolio flows, currency depreciations, reserve losses, and financial stability risks, besides the global inflation shock. As external demand deteriorates, their macroeconomic outlook is becoming increasingly adverse.

Domestic Economy

Real gross domestic product (GDP) grew year-on-year (y-o-y) by 13.5 percent in Q1:2022-23. While all constituents of domestic aggregate demand expanded y-o-y and exceeded their pre-pandemic levels, the drag from net exports provided an offset. On the supply side, gross value added (GVA) rose by 12.7 percent in Q1:2022-23, with all constituents recording y-o-y growth and most notably, services.

Aggregate supply conditions are improving. With the southwest monsoon rainfall 7 percent above the long-period average (LPA) as on September 29 and its spatial distribution spreading to some deficit areas, Kharif sowing has been catching up. Acreage was 1.7 percent above the normal sown area as on September 23 and only 1.2 percent below last year’s coverage. The production of Kharif foodgrains as per first advance estimates (FAE) was 3.9 percent below last year’s fourth advance estimates (only 0.4 percent below last year’s FAE). Activity in the industry and services sectors remains in expansion, especially the latter, as reflected in purchasing managers indices (PMIs) and other high-frequency indicators. The index of industrial production growth, however, slowed to 2.4 percent (y-o-y) in July.

On the demand side, urban consumption is being lifted by discretionary spending ahead of the festival season and rural demand is gradually improving. Investment demand is also gaining traction, as reflected in rising imports and domestic production of capital goods, steel consumption, and cement production. Merchandise exports posted a modest expansion in August. Non-oil non-gold imports remained buoyant.

CPI inflation rose to 7.0 percent (y-o-y) in August 2022 from 6.7 percent in July as food inflation moved higher, driven by prices of cereals, vegetables, pulses, spices, and milk. Fuel inflation moderated with a reduction in kerosene (PDS) prices, though it remained in double digits. Core CPI (i.e., CPI excluding food and fuel) inflation remained sticky at heightened levels, with upside pressures across various constituent goods and services.

Overall system liquidity remained in surplus, with the average daily absorption under the liquidity adjustment facility (LAF) easing to ₹2.3 lakh crore during August-September (up to September 28, 2022) from ₹3.8 lakh crore in June-July. Money supply (M3) expanded y-o-y by 8.9 percent, with aggregate deposits of commercial banks growing by 9.5 percent and bank credit by 16.2 percent as on September 9, 2022. India’s foreign exchange reserves were placed at US$ 537.5 billion as on September 23, 2022.

Outlook

High and protracted uncertainty surrounding the course of geopolitical conditions weighs heavily on the inflation outlook. Commodity prices, however, have softened and recession risks in advanced economies (AEs) are rising. On the domestic front, the late recovery in sowing augurs well for Kharif output. The prospects for the Rabi crop are buffered by comfortable reservoir levels. The risk of crop damage from excessive/unseasonal rains, however, remains. These factors have implications for the food price outlook.

Elevated imported inflation pressures remain an upside risk for the future trajectory of inflation, amplified by the continuing appreciation of the US dollar. The outlook for crude oil prices is highly uncertain and tethered to geopolitical developments, with attendant concerns relating to both supply and demand. The Reserve Bank’s enterprise surveys point to some easing of input cost and output price pressures across manufacturing, services, and infrastructure firms; however, the pass-through of input costs to prices remains incomplete.

Taking into account these factors and an average crude oil price (Indian basket) of US$ 100 per barrel, inflation is projected at 6.7 percent in 2022-23, with Q2 at 7.1 percent; Q3 at 6.5 percent; and Q4 at 5.8 percent, and risks are evenly balanced. CPI inflation for Q1:2023-24 is projected at 5.0 percent.

On growth, the improving outlook for agriculture and allied activities and the rebound in services are boosting the prospects for aggregate supply. The Government’s continued thrust on capex, improvement in capacity utilization in manufacturing, and pick-up in non-food credit should sustain the expansion in the industrial activity that stalled in July.

The outlook for aggregate demand is positive, with rural demand catching up and urban demand expected to strengthen further with the typical upturn in the second half of the year. According to the RBI’s surveys, the consumer outlook remains stable and firms in manufacturing, services, and infrastructure sectors are optimistic about demand conditions and sales prospects. On the other hand, headwinds from geopolitical tensions, tightening global financial conditions, and slowing external demand pose downside risks to net exports and hence to India’s GDP outlook.

Taking all these factors into consideration, real GDP growth for 2022-23 is projected at 7.0 percent with Q2 at 6.3 percent; Q3 at 4.6 percent; Q4 at 4.6 percent, and risks broadly balanced. For Q1:2023-24, it is projected at 7.2 percent.

In the MPC’s view, inflation is likely to be above the upper tolerance level of 6 percent through the first three quarters of 2022-23, with core inflation remaining high. The outlook is fraught with considerable uncertainty, given the volatile geopolitical situation, global financial market volatility, and supply disruptions. Meanwhile, domestic economic activity is holding up well and is expected to be buoyant in H2:2022-23, supported by festive season demand amidst consumer and business optimism.

The MPC is of the view that further calibrated monetary policy action is warranted to keep inflation expectations anchored, restrain the broadening of price pressures, and pre-empt second-round effects. The MPC feels that this action will support medium-term growth prospects. Accordingly, the MPC decided to increase the policy repo rate by 50 basis points to 5.90 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.

Dr. Shashanka Bhide, Prof. Jayanth R. Varma, Dr. Rajiv Ranjan, Dr. Michael Debabrata Patra, and Shri Shaktikanta Das voted to increase the policy repo rate by 50 basis points. Dr. Ashima Goyal voted to increase the repo rate by 35 basis points.

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

Governor’s Statement

In the last two and half years, the world has witnessed two major shocks – the COVID-19 pandemic and the conflict in Ukraine. These shocks have produced a profound impact on the global economy. As if that was not enough- now we are in the midst of a third major shock – a storm – arising from aggressive monetary policy actions and even more aggressive communication from Advanced Economy (AE) central banks.

The necessity of such actions is driven by their domestic considerations, but in a highly integrated global financial system, they inevitably cause negative externalities through global spillovers. The recent sharp rate hikes and forward guidance about further big rate hikes have caused a tightening of financial conditions, extreme volatility and risk aversion. All segments of the financial market including equity, bond, and currency markets are in turmoil across countries. There is nervousness in financial markets with potential consequences for the real economy and financial stability. The global economy is in the eye of a new storm.

Despite this unsettling global environment, the Indian economy continues to be resilient. There is macroeconomic stability. The financial system remains intact, with improved performance parameters. The country has withstood the shocks from COVID-19 and the conflict in Ukraine. Our journey over the last two and half years, and our steely resolve in dealing with the various challenges give us the confidence to deal with the new storm that we are confronted with.

Decisions and Deliberations of the Monetary Policy Committee (MPC)

The Monetary Policy Committee (MPC) met on the 28th, 29th, and 30th of September 2022. Based on an assessment of the macroeconomic situation and its outlook---(you guessed it right)--the MPC decided by a majority of five members out of six to increase the policy repo rate by 50 basis points to 5.9 percent, with immediate effect. Consequently, the standing deposit facility (SDF) rate stands adjusted to 5.65 percent; and the marginal standing facility (MSF) rate and the Bank Rate to 6.15 percent. The MPC also decided by a majority of 5 out of 6 members to remain focused on the withdrawal of accommodation to ensure that inflation remains within the target going forward while supporting growth.

I would now explain the MPC’s rationale for its decisions on the policy rate and its stance. The global economic outlook continues to be bleak. Financial conditions are tightening and recession fears are mounting. Inflation continues to persist at alarmingly high levels across jurisdictions. The enduring effects of the pandemic and the geo-political conflict are manifesting in demand-supply mismatches of goods and services. Central banks are charting new territory with aggressive rate hikes, even if it entails sacrificing growth in the near term.

In this milieu, nervous investor sentiments have triggered a flight to safety. The US dollar has strengthened rapidly to a two-decade high. Several advanced and emerging market currencies are facing sharp depreciation pressures. Emerging market economies (EMEs), in particular, are confronted with challenges of slowing global growth, elevated food and energy prices, spillovers from advanced economy policy normalization, debt distress, and sharp currency depreciations.

Against this challenging global environment, economic activity in India remains stable. While real GDP growth in Q1:2022-23 turned out to be lower than our expectations, the late recovery in Kharif sowing, the comfortable reservoir levels, improvement in capacity utilization, buoyant bank credit expansion, and the government’s continued thrust on capital expenditure are expected to support aggregate demand and output in H2:2022-23.

Consumer price inflation remains elevated and above the upper tolerance band of the target due to large adverse supply shocks, some firming up of domestic demand, and spillovers from global financial markets. The recent correction in global commodity prices including crude oil, if sustained, may ease cost pressures in the coming months. The inflation trajectory remains clouded with uncertainties arising from continuing geopolitical tensions and nervous global financial market sentiments.

Against this backdrop, the MPC was of the view that the persistence of high inflation necessitates further calibrated withdrawal of monetary accommodation to restrain the broadening of price pressures, anchor inflation expectations, and contain the second-round effects. This action will support medium-term growth prospects. Accordingly, the MPC decided to increase the policy repo rate by 50 basis points to 5.9 percent and to remain focused on the withdrawal of accommodation, while supporting growth.

Let me step back and elaborate on our monetary policy stance. Monetary policy had moved from a neutral to an accommodative stance in June 2019. At that time, the repo rate was 5.75 percent; headline CPI inflation was hovering around 3 percent and was expected to be in the range of 3.4 to 3.7 percent in H2:2019-20; and, liquidity was in deficit mode, with an average daily net injection of ₹0.3 lakh crore in May 2019 under the liquidity adjustment facility (LAF).

Today, inflation is hovering around 7 percent and we expect it to remain elevated at around 6 percent in H2:2022-23. Liquidity remains surplus, with average daily net absorption of ₹1.1 lakh crore under the LAF in September 2022 (up to September 28). As government expenditure picks up on the back of high GST and direct tax collections, the system liquidity will go up further. Thus, even as the nominal policy repo rate has been raised by 190 basis points so far (including today’s increase), the policy rate adjusted for inflation trails the 2019 levels. The overall monetary and liquidity conditions, therefore, remain accommodative, and hence, the MPC decided to remain focused on the withdrawal of accommodation.

Assessment of Growth and Inflation

Growth

Real GDP grew by 13.5 percent (y-o-y) in Q1:2022-23, surpassing the pre-pandemic level by 3.8 percent. This was led by robust growth in private consumption and investment demand.

High-frequency data for Q2 indicate that economic activity remains resilient. Private consumption has been holding up. There is a sustained revival in urban demand which should get a further impetus from the unfettered celebration of upcoming festivals after two and half years of living with COVID-19. Rural demand is also gaining gradually.

Investment demand is picking up and is evident from the robust growth of domestic production and the import of capital goods in July and August. Bank credit grew at an accelerated pace of 16.2 percent y-o-y as on September 9, 2022, as against 6.7 percent a year ago. The total flow of financial resources from banks and non-banks to the commercial sector has improved significantly to ₹9.3 lakh crore in this financial year so far (up to September 9) from ₹1.7 lakh crore in the corresponding period of last year.

According to an RBI survey, seasonally adjusted capacity utilization of the manufacturing sector improved from 73.0 percent in Q4: 2021-22 to 74.3 percent in Q1:2022-23 - its highest level in three years (1). Non-oil non-gold imports remained resilient, indicating a sustained revival in domestic demand. Merchandise exports growth, however, faced headwinds in an unsettled external environment.

On the supply side, the agricultural sector remains resilient. The monsoon rainfall was 7 percent above the long-period average (LPA) as on September 29. Kharif sowing was 1.7 percent above the normal sown area as on September 23. The production of Kharif foodgrains as per the first advance estimate is only 0.4 percent below the first advance estimate of last year. The reservoir levels are at 87 percent of the full capacity on September 29, 2022, as against the decadal average of 77 percent. This augurs well for the ensuing Rabi crop.

Industrial activity, reflected in the growth of the index of industrial production (IIP) (y-o-y), slipped to 2.4 percent in July. India’s manufacturing purchasing managers index (PMI), however, indicates sustained expansion at 56.2 in August. Business sentiment, as reflected in the manufacturing PMI, strengthened with a degree of optimism at its highest in six years. Services sector indicators (2) point towards strong growth in July and August. Services PMI rebounded to 57.2 in August from 55.5 in July. Business confidence rose to a 51-month high.

Looking ahead, all these factors (3) should support aggregate demand and activity. The headwinds from extended geopolitical tensions, tightening global financial conditions, and a possible decline in the external component of aggregate demand can pose downside risks to growth. Taking all these factors into consideration, real GDP growth for 2022-23 is projected at 7.0 percent with Q2 at 6.3 percent; Q3 at 4.6 percent; and Q4:2022-23 at 4.6 percent, with risks broadly balanced. The growth for Q1:2023-24 is projected at 7.2 percent.

Inflation

Global geopolitical developments are weighing heavily on the domestic inflation trajectory. Inflation inched up to 7.0 percent in August from 6.7 percent in July.

Acute imported inflation pressures felt at the beginning of the financial year have eased but remain elevated across food and energy items. Edible oil price pressures are likely to remain contained on improved supply from key producing countries and measures taken by the Government. Going forward, there could be some tapering of selling price increases on account of easing supply conditions and softening of industrial metal and crude oil prices. With services activity showing a strong rebound and some improvement in pricing power, risks of higher pass-through of input costs, however, do remain.

There are also upside risks to food prices. Cereal price pressure is spreading from wheat to rice due to the likely lower Kharif paddy production. The lower sowing for Kharif pulses could also cause some pressure. The delayed withdrawal of monsoon and intense rain spells in various regions has already started to impact vegetable prices, especially tomatoes. These risks to food inflation could have an adverse impact on inflation expectations.

The Indian basket crude oil price was around US$ 104 per barrel in H1:2022-23. Going forward, we are now assuming it to be US$ 100 per barrel in H2:2022-23. Taking into account these factors, the inflation projection is retained at 6.7 percent in 2022-23, with Q2 at 7.1 percent; Q3 at 6.5 percent; and Q4 at 5.8 percent, with risks evenly balanced. CPI inflation is projected to further reduce to 5.0 percent in Q1:2023-24.

The extraordinary global circumstances that caused the heightened inflationary pressures have impacted both AEs and EMEs. India is, however, better placed than many of these economies. If high inflation is allowed to linger, it invariably triggers second-order effects and unsettles expectations. Therefore, monetary policy has to carry forward its calibrated action on policy rates and liquidity conditions consistent with the evolving inflation growth dynamics. It must remain alert and nimble.

Liquidity and Financial Market Conditions

During the current financial year, the weighted average call rate (WACR) – the operating target of monetary policy – has increased cumulatively by 196 bps in a phased manner (up to September 28) over March 2022. This is in sync with our actions on the SDF and the repo rate. Consequently, interest rates across the financial market spectrum4 have increased, though at varying degrees.

Surplus liquidity in the banking system, as reflected in average daily absorptions under the liquidity adjustment facility (LAF) [both SDF and variable rate reverse repo (VRRR) auctions], moderated to ₹2.3 lakh crore during August - September 2022 (up to September 28) from ₹3.8 lakh crore during June-July. GST and advance tax payments coupled with forex outflows moderated the surplus liquidity conditions in the third week of September. This necessitated recourse to the marginal standing facility (MSF) by banks and liquidity injection by the RBI through variable rate repo (VRR) auctions.

This temporary moderation of surplus liquidity needs to be seen in the context of the large potential liquidity in the system arising from the expected pick-up in government spending that usually happens in the second half of the year. Furthermore, the drawdown of excess cash reserve ratio (CRR) and excess statutory liquidity ratio (SLR) holdings of banks can also augment system liquidity.

In my policy statement of October 2021, I had stated that the RBI may complement the fortnightly main operation conducted through 14-day VRRR auctions with 28-day VRRR auctions depending upon the evolving liquidity conditions. In view of the moderation in surplus liquidity, it has now been decided to merge the 28-day VRRR with the fortnightly 14-day main auction. Consequently, from now on, only 14-day VRRR auctions will be conducted. Fine-tuning operations of various maturities for absorption as well as injection of liquidity will continue as may be necessary from time to time.

During the current financial year (up to September 28), the US dollar has appreciated by 14.5 percent against a basket of major currencies. This has caused turmoil in currency markets globally. The movement of the Indian Rupee (INR) has, however, been orderly compared to most other countries. It has depreciated by 7.4 percent against the US dollar during the same period – faring much better than several reserve currencies as well as many of its EME and Asian peers.

A stable exchange rate is a beacon of financial and overall macroeconomic stability and market confidence. In recent days, there have been divergent views on the exchange rate of the rupee and the adequacy of our forex reserves. Let me set out the overall position once again.

First, the rupee is a freely floating currency and its exchange rate is market-determined. Second, the RBI does not have any fixed exchange rate in mind. It intervenes in the market to curb excessive volatility and anchor expectations. The overarching focus is on maintaining macroeconomic stability and market confidence. Our actions have helped in engendering investor confidence as reflected in the return of capital inflows since July.

Over the medium term, the primacy of price stability embedded in our flexible inflation targeting (FIT) framework provides the anchor for exchange rate stability. Third, our interventions in the forex market are based on continuous assessment of the prevailing and evolving situation from the point of view of our approach which I just explained. The aspect of the adequacy of forex reserves is always kept in mind. The umbrella continues to be strong.

During the pandemic, forward guidance gained prominence in the Reserve Bank’s communication strategy. This was helpful in anchoring market expectations. In a policy tightening cycle, however, it is arduous to provide consistent forward guidance, particularly in a highly uncertain environment. In fact, forward guidance may even destabilize financial markets.

Questions are often asked about the peak and terminal rates in a rate-tightening cycle. Without venturing into any forward guidance which can be hazardous in the present context, I would like to state that our actions will be carefully calibrated to the incoming data and evolving scenario without being constrained by conventional or any textbook approach to policy making.

External Sector

The current account deficit (CAD) for Q1:2022-23 is placed at 2.8 percent of GDP with a trade deficit at 8.1 percent of GDP. Various leading indicators, including global PMIs, point to a weakening of global growth momentum and downside risks to global trade. India’s import growth, though decelerating (5), outpaced export growth. Consequently, the trade deficit remained high in July-August 2022. Services exports continued to grow at a robust pace amidst resilient demand for software and business services and a modest recovery in travel services.

On a balance of payments (BOP) basis, for which data were released yesterday, exports of services grew at a robust pace of 35.4 percent (y-o-y) in April-June this year. For the same period, remittances rose by 22.6 percent. The net surplus on exports of services is expected to partly offset the higher trade deficit.

From the external financing side, net foreign direct investment (FDI) improved to US$ 18.9 billion in April-July 2022 from US$ 13.1 billion a year ago. Foreign portfolio investors (FPIs) have returned to the domestic market with a net inflow of US$ 7.5 billion during July-September after an outflow for nine consecutive months.

India’s foreign exchange reserve at US$ 537.5 billion as on September 23, 2022, compares favorably with most peer economies. About 67 percent of the decline in reserves during the current financial year is due to valuation changes arising from an appreciating US dollar and higher US bond yields. Incidentally, there was an accretion of US$ 4.6 billion to the foreign exchange reserves on a balance of payments (BOP) basis during Q1:2022-23.

India’s other external indicators, viz., external debt to GDP ratio; net international investment position to GDP ratio; ratio of short-term debt to reserves; and debt service ratio also indicate lower vulnerability as compared with most other major EMEs (6). In fact, India’s external debt to GDP ratio is the lowest among major EMEs. In the final analysis, we remain confident of meeting our external financing requirements comfortably.

Additional Measures

I shall now announce certain additional measures.

Discussion Paper on Expected Loss (EL) Based Approach for Loan Loss Provisioning by Banks

Banks currently follow the incurred loss approach for provisioning on their loan assets, whereby provisions on loan assets are made after the stress has materialized. A more prudent and forward-looking approach is the expected loss-based approach, which requires banks to make provisions based on an assessment of probable losses. As a step towards converging with globally accepted prudential norms, we will issue a discussion paper on the proposed transition for stakeholder comments.

Discussion Paper on Securitization of Stressed Assets Framework (SSAF)

The revised framework for the securitization of standard assets was issued by the Reserve Bank in September 2021. It has now been decided to introduce a framework for the securitization of stressed assets. This will provide an alternative mechanism for the securitization of NPAs, in addition to the existing ARC route. A Discussion Paper (DP) on the proposed framework is being issued for feedback from stakeholders.

Internet Banking Facility for Customers of RRBs

Regional Rural Banks (RRBs) are currently allowed to provide Internet Banking facilities to their customers, subject to the fulfillment of certain criteria. Keeping in view the need to promote the spread of digital banking in rural areas, these criteria are being rationalized. The revised guidelines will be issued separately.

Regulating Offline Payment Aggregators

Online Payment Aggregators (PAs) have been brought under the purview of RBI regulations since March 2020. It is now proposed to extend these regulations to offline PAs, who handle proximity/ face-to-face transactions. This measure is expected to bring in regulatory synergy and convergence on data standards.

Conclusion

Daunting challenges confront us at this juncture. The underlying fundamentals of our economy and the buffers built over the years have stood us in good stead. We have taken a series of measures since April 2022 against the backdrop of geopolitical tensions, sanctions, and supply chain disruptions. We will remain resolute and persevere in our efforts to ensure price stability as well as financial stability while supporting growth. Our policy action today is part of our continued efforts in pursuit of these goals. As we celebrate Mahatma Gandhi’s birth anniversary in another two days, I conclude my statement with his insightful words: “…we are ever wakeful, ever vigilant, ever striving.”  Today, despite the gathering of clouds over the global economy, the Indian economy inspires optimism and confidence.

Thank you. Namaskar---

Notes:

1. This is notwithstanding the decline in unadjusted capacity utilization from 75.3 percent to 72.4 percent over the same period reflecting a seasonal pattern.

2. Railway freight traffic; port freight traffic; domestic air passenger traffic; e-way bills; toll collections, etc.

3. The recovery in Kharif sowing, adequate reservoir levels, an upsurge in discretionary spending, moderation in commodity prices, Government’s continued thrust on capex, improvement in capacity utilization in manufacturing, pick-up in bank credit, and waning COVID-19 infections.

4. 91-day treasury bills, commercial paper (CPs) and certificates of deposit (CDs), and bond yields. (The rate hikes also triggered an upward adjustment in the benchmark lending rates of banks. In tandem, term deposit rates have also increased as banks compete for mobilizing resources to meet the resurgent credit demand.)

5. Growth in merchandise imports moderated from 49.5 percent in Q1:2022-23 to 43.6 percent in July and 37.3 percent in August 2022.

6. Net international investment position to GDP ratio is in terms of net claims of non-residents in India and the ratio of short-term debt to reserves is measured in terms of residual maturity.

Opening statement by RBI Governor Das in the presser/Q&A session:

---I just listed out a few points as the highlights of the MPC decisions and the highlights of the MPC statement. I have got nine points.

First, the world is in the eye of a new storm.

Second, India's growth remains resilient.

Third, domestic inflation is high, but it is expected to moderate.

Four, the most obvious, is the rate hike of 50 basis points and the stance continues to be ‘Withdrawal of Accommodation.’

Five, liquidity continues to be in surplus and henceforth on the liquidity front, only 14-day VRRR (Variable Rate Reverse Repo) options will be conducted. We will continue with our two-way fine-tuning operations for injection as well as absorption of liquidity.

Six, amidst currency market turmoil the world over, the Indian rupee has seen orderly depreciation.

Seven, our focus is on prudent intervention in the Forex market and prudent management of the foreign exchange reserves.

Eight, India's external sector remains sound and resilient.

Nine, going forward, monetary policy will be watchful and nimble, based on incoming data and evolving situations.

Highlights of RBI Presser (Q&A):

·         RBI decisions and actions on monetary policy and currency management will be as per evolving domestic macroeconomic situations irrespective of Fed action. RBI is giving priority to price stability (inflation management) while keeping economic growth in mind; i.e. RBI will bring down inflation to target ensuring a safe and soft landing; maintaining price stability is now RBI’s primary objective, while the requirement of economic growth secondary

·         “The MPC decisions, as you have pointed out, continue to be guided and will be guided by domestic factors. There are two components in the monetary policy framework; one is inflation, and the second one is we are required to keep the requirements of growth in mind. So, it is inflation and growth. Monetary policy committee decisions are based on twin objectives with primacy being given to price stability, followed by the necessity to keep growth in mind”.

·         RBI is intervening in the currency (FX) market to ensure orderly movement while keeping in mind higher imported inflation for higher USDINR, but this is not the prime consideration of the MPC. The guiding policy of RBI’s monetary policy decisions is based on domestic inflation-growth dynamics rather than managing currency

·         “Other than that, currency market fluctuations, depreciation of the rupee, or appreciation of the rupee is not a factor which is for consideration by the monetary policy committee. The RBI has other instruments which will be deployed as per requirement for dealing with those situations. Just to confirm, currency movements are not the guiding factors for our monetary policy decisions which are based on the domestic inflation growth dynamics.”

·         RBI is ensuring the orderly movement of the Rupee (USDINR); i.e. not allowing sudden decline or appreciation. RBI is trying to ensure orderly USDINR movement as per domestic macroeconomic situation/fundamentals (current/evolving) and movement of USD/other important global currencies in the global market.

·         “Volatility would mean a sudden decline or a sudden appreciation. Now, what is that sudden; it's not possible to quantify. It's based on our assessment. You have to see all around what is happening, the world over what is happening to the other currencies also you have to keep it in mind. You have to keep in mind also our domestic macroeconomic fundamentals. Whether the exchange rates are going out of sync with our macroeconomic fundamentals. So, there are various considerations that go into our decision. But this is monitored continuously, almost every day on an ongoing basis, and based on that decisions are taken.”

·         Although some MPC members have used the word ‘frontloading’ of interest rate hikes in their individual statements (minutes), RBI has not mentioned the word in its official resolution of the statement. RBI is using the word ‘calibrated tightening’ as per the evolving and anticipated situation.

·         “First, you talked about front loading. Frontloading if you see, to the best of my recollection, it's not there in the MPC resolution or my statement. Frontloading has been mentioned by the individual members of MPC in their respective minutes. MPC resolution over the last three or four meetings and today, we have not used the word frontloading. That is the perception of each member. So, therefore, all that we have said in the MPC resolution and my statement is that it is calibrated to the evolving and anticipated situation.”

·         Apart from COVID and Russia-Ukraine war disruptions, RBI mentioned about 3^rd global disruption, which is ongoing currency devaluations of major and developing economies against stronger USD and the subsequent risk to financial and macro stability. RBI is concerned about global spillovers of the Fed’s aggressive tightening and forward guidance policies and the Indian economy, being part of the same global system, INR is also susceptible to sharp devaluation, risking higher imported inflation. But so far Indian currency and bond yield are moving in a much more orderly manner than most of the EME peers due to the stability of Indian macros and active RBI intervention.

·         “Now, the second question you asked was about the third force. The third major shock has indeed been a shock which has further accentuated the overall situation in the global financial markets. It has had its impact on creating excessive volatility in currency markets in particular. When currency depreciation takes all over the world; it happened all over the world, let me talk about the Indian situation. Naturally, the whole scenario of imported inflation plays out and that is built into our inflation projections. Currencies are depreciating. Financial markets are seeing excessive volatility.”

·         “Our bond yields have moved in a very orderly manner, but the world over if you see, bond yields are very volatile. So, the third shock as we see has added to the already heightened uncertainty which was prevailing. The forward guidance given by the US Fed in particular also talks of future rate hikes and they are pretty big rate hikes. So, the overall stress on the global financial system has become much more in the aftermath of the monetary policy tightening and communication by the advanced countries' central banks. Nobody is blaming anyone. They have their domestic necessities and requirements for which they are doing. But we have to deal with the spillovers.”

·         Banking/money market liquidity is not tight or in deficit contrary to the street perception and RBI is doing both liquidity injection and absorption as per the evolving situation

·         “Regarding overnight, I have said in my statement that as in the past we will continue to do the fine-tuning operations in both directions to absorb as well as to inject. But coming to what you said liquidity is tight, let me say very clearly the liquidity is not tight. The net LAF continues to be in surplus for more than two years except I think maybe two, or three days when because of the Standing Liquidity Facility as we call it, the SLF for the primary dealers, if you take that into account, then it became a deficit. But the net LAF has remained positive throughout the last two and half years or so.”

·         “Secondly, many banks are holding excess SLR and excess CRR and some of them have also started dipping into their excess CRR and excess SLR because they need the cash to support and sustain their lending operations.”

·         “Further, there is a temporary movement of liquidity from the system which has gone into a different basket because of high GST and direct tax collections. Second-half expenditures of Governments are always very high. When I say government, I include both State and central government. So, they are very high. Today, for example, the salary payments will take place, and the additional DA payments will take place. Usually, government expenditure picks up very well. So, that will come back. So, if you take everything into account, the system liquidity is in the order of let's say about 5 lakh crore. So, I think there should not be any concern about liquidity being suddenly tight.”

·         RBI Dy. Governor Patra: RBI cuts FY23 GDP growth projections from +7.2% to +7.00% as Q1FY23 data came below projections as per a preliminary estimate by the NSO. RBI is confident about the rest of the financial quarters and projected a pickup in momentum. Maintaining price stability is now RBI’s primary mandate while maintaining economic growth is a secondary mandate (RBI has now virtually dual mandate). RBI sees the question of a soft landing for advanced economies, but it’s a take-off for the Indian economy

·         “The adjustment in projections taking into account the release of the first quarter data by the National Statistical Commission, which came below our forecast. Otherwise, if you see the rest of the quarters, there is actually a pickup in momentum. So, we remain focused on price stability as a primary goal, but we have a dual mandate, so we do take into account the concerns of growth. On the issue of a soft landing, a soft landing is for advanced economies. For India, it is take-off.”

·         RBI is not making or committing any firm forward guidance on whether it will change its present monetary policy stance once system liquidity goes into deficit and the real rate becomes positive

·         “We will have to wait and see because the situation is playing out and I would not like to tie up myself with any specific formulation like that and fuel some kind of market expectation about the future course of action. I have only explained the overall monetary conditions taking into account the liquidity and the repo rate and inflation – the current inflation as well as six months ahead inflation. I have only said that the monetary conditions are still accommodative. Going forward, we will constantly reevaluate, and as and when required, we will spell out whatever the decision is at that point in time.”

·      Although RBI sees inflation come down close to the 4% target over a 2-year cycle (by FY24 or Mar’25), there are many global uncertainties at present and coming days. RBI will not divulge the content of its reply to the Federal government about high inflation

·         “We will write a letter to the government. So, let me not pre-empt what we will write to the Government. If you see the legal provisions under the RBI Act, the regulations, and the rules, MPC has to have a meeting to discuss the Reserve Bank's reply to the government. So, what we will write, I will not say. But as I have said earlier, we are expecting the inflation to come down close to the target over a two-year cycle that was our expectation earlier and even now. But then again, there are so many uncertainties that are playing out and coming in from time to time.”

·         RBI Dy. Governor Patra: RBI sees easing of currently tight liquidity conditions from October

·         “As Governor mentioned, the overnight rates started crawling up and the advance tax went out in the system. Currently, the market is facing a half-yearly balance sheet on September 30th. So, there is a calculated tactic. We expect that to ease from October itself as it will close.”

·         Deposit rates will gradually pick up in the coming days (in line with lending rates, which have already shot up)

·         “Our external benchmark is linked to the lending rates, but I have answered this question even in an earlier MPC that the bank credit is now picking up. There is still surplus liquidity in the system, but all of you are talking about liquidity tightness. Credit is picking up, so obviously, the banks need more resources for which they have to necessarily raise their deposit rates. The repo rates have been increased by 190 basis points after we started this cycle of raising interest rates. Yesterday the Government has increased the small savings rates by 20 to 30 basis points in about three or four instruments. So, I think all these factors are taken together, the banks will going forward, I am sure the banks will consider and increase deposit rates.”

·         “Around 15th August, many banks introduced new products – many new deposit schemes. So going forward, we expect that, you will see more traction with regard to the adjustment of deposit rates”

·         RBI Dy. Governor Jain: “The monetary policy, generally, targets lending rates. The deposit rate in a hardening interest rate scenario is always having a lag. As Governor has said, there is enough liquidity available in the system, and when enough liquidity is available in the system that is being utilized by the banks. Governor also talked in a statement about excess SLR, so overall if we have to see the CD ratio, the CD ratio has not gone up much. The incremental CD ratio is being met by the banks through various sources of their funding, including raising the Commercial Deposits as well as the Bulk Deposit. So, we are not seeing any trend or the mismatch in the ALM, structured liquidity on a short end. The LCR is also very high, pretty high.”

·         India is less vulnerable to FX outflow as it has strong macros and high levels of buffers including adequate FX reserve despite some recent depletion, but RBI constantly evaluates it

·         As regards the adequacy of reserves, I have addressed this point in the Monetary Policy Statement where I have mentioned the various vulnerabilities of any country’s reserve, and how we stand compared to other emerging market economies and other countries. Almost in all parameters, our vulnerability is far less than most of the emerging market economies. It is a process of constant evaluation that we do and we will take a call depending. Interestingly, I also mentioned this point to dispel any public sort of notion”.

·         “During April-June 2022, there has been an accretion of US$4.6 billion on a BOP basis. In our assessment, taking into account the current level of reserves and the various vulnerability indicators vis-à-vis the external sector, we are comfortably placed, and our buffers are quite strong.”

·         RBI will not provide any firm forward guidance about levels of likely terminal rate and will not clarify further about any real rate levels despite comparing pre-COVID real rate levels (in 2019), which were around +2.75% of the then average CPI

·         “Well, I don’t want to repeat what I said, but I would request Dr. Michael Patra if he can put it in a different manner or explain the same thing in his language.”

·         Patra: RBI may slow rate hikes once inflation falls well into the tolerance band (say +5.00%) and may pause rate hikes, once inflation gets closer to target (+4.00%)

·         “I actually have talked about this before. So, the issue is not a sojourn but a journey, and the journey is two milestones, where inflation gets into the tolerance band and when its alliance with the target, you will know”.

·         RBI is not targeting a particular/specific level of the Rupee (USDINR); the level is dependent on macroeconomic fundamentals and the overall global situation. RBI doesn’t have a specific target

·         “I can’t answer that question, the level at which RBI will be comfortable. In any case, you see the global situation is constantly changing. As a Central Bank, I have said that we don’t have any specific level of the Rupee in mind. It all depends on our macroeconomic fundamentals. It depends on the overall global situation. We don’t target a specific rate. When I am saying it, it’s not just a part of the usual conventional lexicon of RBI, we mean it. We don’t have a specific level of the Rupee.”

·         Government/RBI effort to settle external trade with INR has a good initial response from 5-6 countries at least

·         Despite elevated merchandise trade deficit, RBI is confident to keep CAD (Current Account Deficit) under 3% of GDP for a full year (FY23) amid robust service export and softening of crude oil prices

·         “We are watching the trade deficit, but they are other moving parts in the balance of payments like one thing that has happened is that oil prices have eased a bit, so the oil import bill will be lower. Windfall taxes have been slashed so petroleum exports have grown 23 percent in August. Services exports are doing very well and they are now getting a boost from travel because tourism has picked up in a big way. All in all, we expect that the current account deficit may widen modestly in the first half but narrow in the second half. Overall, we expect it to be under three percent of GDP.”

·         As a central bank, RBI will always try to maintain price as well as financial stability even under a stressful situation/synchronized global recession; RBI does not see an all-out economic recession for India; RBI is optimistic and confident

·         “I cannot comment on opinions that are expressed by eminent persons, eminent thinkers, and economists. There are so many opinions that are expressed in the market, in the media and the various academic journals. We get to read and go through all of them. Internally also our research teams do look at them very carefully, and very intensively. So far as India is concerned, as I have said, our buffers are very strong. Our focus is always on maintaining financial stability and macroeconomic stability. The Reserve Bank as a Central Bank has to maintain price stability and financial stability which is an uppermost objective of the Reserve Bank, like any other central bank.”

·         “At this point, I also mention that having weathered the two major shocks over the last two and a half years, if you recall, when the COVID-19 pandemic started, the expectations were that all countries will take a massive hit. Our FSR (Financial Stability Report) models, for example, the stress tests showed that under severe stress conditions the NPAs and GNPAs can go up to 16 percent plus. That did not happen. That didn’t happen, just like that. It did not happen, because the Reserve Bank intervened and came out with various announcements. We gave a moratorium, and we gave a very calibrated, targeted, and not open-ended, and very prudent resolution framework. We have a separate framework for the MSMEs.”

·         “So, throughout the pandemic and then after the war has started, the Reserve Bank responded from time to time. We draw confidence from the fact that how all of us as a country have dealt with it. I must also mention the fiscal action which was also very timely, prudent, and targeted. The way the country dealt with the entire vaccination issue. But coming back to the Reserve Bank, we have dealt with challenges in the past. There are challenges in front of us, ahead of us. Buffers continue to be strong. Our priority is price and financial stability. I ended my statement by saying that the prospects of the Indian economy, there is optimism and there is confidence.”

·         RBI projected FY23 GDP growth at +7.0% from earlier +7.2% based on the latest NSO revisions and high-frequency indicators and thinks that it’s a fair estimate than being too optimistic

·         “As I mentioned, we took into account the revised number that was put out by the National Statistic Office for the first Quarter. We also took into account the high-frequency indicators for the rest of the year that are available till now. We see a quickening of momentum in the second Quarter. We have slightly adjusted our quarterly path and therefore it is at seven percent.”

·         India’s macroeconomic situation continues to be very resilient, which gives RBI the confidence for a safe and soft landing despite the chorus of synchronized global recession

·         “What we need to do, you will see as the situation unfolds. Because I frankly don’t know what are the new challenges and what are new factors will come up. So, as and when they come up, we will respond to that. But we also try and anticipate what could happen. At this point, I cannot say what we will do next; it will depend on how the situation evolves. But our overall macroeconomic fundamentals and the financial sector are displaying improved performance parameters, whether you look at the provision coverage ratio of the banks or you look at the GNPA or the capital adequacy in all respects, the banks and non-banks, remain quite resilient. That’s about the financial sector.”

·         “The inflation levels, we have projected it is expected to moderate going forward. They are high at present. Seven percent is the number that we have for August which was published on September 12th and there is an expectation that the September number could be a little higher than seven percent. But that is already factored into our calculation. We have provided the path that this year we will still have 6.7 percent. Growth also at this point– there are many indicators which point to the resilience of activities and activities are picking up – looks strong. So, our overall situation in India continues to be very resilient and that gives us confidence.”

·         RBI will not make public the contents of the inflation letter to the government as it’s a privileged communication

·         “The Act doesn’t provide any frequency of writing that letter because there is no such provision. It is a privileged communication between the Reserve Bank and the Government, so at this point in time; I cannot say whether it will be made public. From our side, we will not make it public because it is a privileged communication from the Central Bank to the Government.”  

·         RBI has no official interest rate differential target with Fed; RBI’s policy actions are based on India’s domestic macroeconomic situation

·         “With regard to the interest rate differential as I mentioned, our monetary policy decisions are not determined by what rates prevail or what rate action is being taken by the other central banks. Our rates and our monetary policy actions will depend on our domestic situation.”

 Conclusions:

RBI sees resilient domestic economic activity but elevated inflation till at least FY23, not only substantially above RBI’s +4.0% target but also above the upper tolerance band of +6.0%. RBI also sees sticky domestic inflation as a function of imported higher inflation and global supply chain disruptions rather than elevated domestic demand and constrained supply. RBI virtually blamed global supply chain disruptions and elevated fuel & food prices for sticky domestic inflation as a result of Russia-Ukraine geopolitical tensions and subsequent economic sanctions (on Russia). RBI is now also concerned about global financial stability after U.K. policy chaos and BOE bailout of British Pension funds amid a plunge in bond prices; i.e. surging bond yields and also USD led by Fed’s faster policy tightening.

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

India’s headline inflation (CPI) jumped +7.41% in September (y/y) and +0.57% sequentially (m/m), while core inflation also surged +6.10% in September from +5.90% reading in August. The average CPI is now around +6.89% (y/y), sequential reading +0.60%; i.e. annualized +7.14%, while average core inflation is around +6.12% (y/y)-all are substantially above RBI target +4.00% and also above RBI’s upper tolerance levels of +6.00%.

RBI’s rate action will be highly dependent on Fed’s policy:

The U.S. employment is now almost at Fed’s maximum level despite some cooling, while inflation (core CPI/PCE) is still substantially above the Fed’s price stability target of +2.00% without any meaningful sign of cooling. The U.S. labor market as well as inflation may begin to cool meaningfully after Q1CY23 amid higher supply (?) and lower demand. Although the U.S. economy is technically in recession after consecutive two quarters of contraction, the labor market is still robust along with consumer spending, while core inflation is at a 40-years high. Thus Fed has no problem with further jumbo rate hikes to a positive real rate, at least wrt core inflation.

As a central bank, Fed can only control the demand side of the economy so that it can match with the currently constrained supply side and bring inflation down to some extent. Although mostly supply issues are now causing higher inflation, amid Russia-Ukraine/NATO war/proxy war and Chinese recurring COVID lockdowns, as a central bank, Fed must act to control demand and inflation; otherwise higher inflation will affect discretionary consumer spending and economic growth in a more durable way.

Fed may hike another +125 bps to reach a +4.50% terminal rate by Dec’22; i.e. Fed may hike +75 bps in November and +50 bps in December. Then Fed may continue to hike either at +50 bps or +25 bps (slower pace) to reach a positive real rate by H1CY23 at least wrt core inflation. Fed goes by core PCE inflation, which was +4.9% in Aug’22 with an average rate of +5.12%.

On the other side, the normal core CPI inflation average is now around +6.20% (till September). Assuming an average of core PCE and core CPI, the median core inflation average is now around +5.50%. Inflation/core inflation may be elevated in Q4CY22 for elevated festival/shopping season demand (higher consumer spending for Festival/holiday season). Thus Fed may hike to at least +5.50% by Mar’23 before any pause in Q2CY23 to gauze the effect of existing higher borrowing costs on overall inflation, and employment / economic growth –both actual data and outlook.

Looking ahead, India’s inflation may surge more amid elevated demand in Festival Season: Q3FY23 (October-November-December’22)-it will also support economic growth at the same time. Thus jumbo Fed hiking, elevated domestic inflation, and robust economic growth may force RBI to continue to follow the Fed hiking path and RBI may hike +0.50% on 7^th December (against Fed’s probable +0.75% on 2^nd November); +0.35% on 8^th February (against Fed’s probable +0.50% on 14^th December and +0.25% in Jan’23) to reach at least +6.75% terminal rate by Feb’23 (against Fed’s +4.75%).

In 2023, depending upon the actual inflation trajectory for Q4CY22 (October, November, and December), Fed may further hike at least 50-100 bps in Q1CY23. Accordingly, RBI has to hike at least +75 bps by June’23 for a terminal rate of +7.50% against the Fed’s +5.50%.

As per Taylor’s rule, for India:

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

Here for RBI/India:

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

As per Taylor’s rule, which Fed policymakers generally follow, assuming India’s ideal real interest at +0.50%, the RBI repo/policy/interest rate should be +7.50% against the present +5.90%. Thus RBI may hike to at least 6.75% by FY23, depending upon the actual trajectory of inflation, which may surge well above +7.00% in the coming days amid higher costs of transportation fuel, and food as-well-as core inflation coupled with elevated Festival demand. If core inflation stabilizes around 5.50% by H1FY23, then RBI may pause rate hikes after June’23.

In his monetary policy statement on 30^th September, RBI Governor Das pointed out pre-COVID era (June 19) real repo rate was around +2.00 to 2.50% as the repo rate was +5.75% against headline CPI around +3.00%, core CPI around +4.00% and 6M inflation expectations was around +3.4 to +3.7% (for H2FY20).    

Fast forward, now RBI inflation expectation for H1FY24 is around +5%. Previously, Das also indicated that RBI will go by 6M inflation expectations, actual average CPI, and also core inflation. India’s core CPI is consistently hovering around +6.00% for the last few years even before COVID and Russia-Ukraine war led to global supply chain disruptions. India has its domestic supply chain issues and also higher demand, mainly due to the rampant flow of corrupt money in the economy generated from various government projects/capex/grants and also fraudulent bank lending. Thus RBI has to tighten the policy and keep the repo rate around +7.50% by June’23, so that the real rate would be around +1.50 to +2.00% wrt at least core inflation (6.50-5.50%).

Note: Latest RBI proposal for stricter NPA provisions based on expected loan loss than actual may be negative for banks & financials and thus the sector came under some stress after the RBI policy.

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