---

RBI may hike further by 25 bps each in April and June before any pause

But RBI may also go for rate cuts in early 2024, just ahead of the general election if India’s sticky core inflation indeed falls below 5% on a sustainable basis

---

On 8^th February, as highly expected, India’s Central Bank RBI hiked all effective policy rates by +0.25% as expected by the market, which is a step down from earlier +0.35% and +0.50% (in line with Fed’s rate action). The RBI repo rate is now at +6.50%, at levels of Jan’19 after the 6^th consecutive rate hike since May’22, totaling +250 bps. RBI also raised the effective reverse repo rate (SDF-Standing Deposit Facility), MSF (Marginal Standing Facility), and Bank rate by +25 bps each to +6.25%, +6.75%, and +6.75% respectively.

RBI lowered its headline inflation (CPI) forecast for FY23 to 6.5% from 6.7% and revised India's real GDP growth to 7% from 6.8%. For the next FY24, RBI projected headline CPI to ease further to 5.3% with an economic (real GDP) growth rate of 6.4%. Some market participants were also expecting a clear message of pause by RBI after the December hike. But RBI didn’t convey any message of pivot (pause) and telegraphed another smaller/calibrated hike of +25 bps in the coming months by keeping ‘Arjuna’s eye’ on the evolving inflation dynamics.

RBI is quite worried about sticky core inflation around +6.00%, at RBI’s upper tolerance band, while upbeat about economic growth amid domestic resilience despite global macro headwinds and subdued merchandise export. Thus there is no concern about a hard landing and RBI may continue to follow Fed and hike rates to bring down core inflation towards 4% targets.

Monetary Policy Statement, 2022-23 Resolution of the Monetary Policy Committee (MPC) February 6-8, 2023

On the basis of an assessment of the current and evolving macroeconomic situation, the Monetary Policy Committee (MPC) at its meeting today (February 8, 2023) decided to:

Increase the policy repo rate under the liquidity adjustment facility (LAF) by 25 basis points to 6.50 percent with immediate effect.

Consequently, the standing deposit facility (SDF) rate stands adjusted to 6.25 percent, and the marginal standing facility (MSF) rate and the Bank Rate to 6.75 percent.

The MPC also decided to remain focused on the withdrawal of accommodation to ensure that inflation remains within the target going forward while supporting growth.

These decisions are in consonance with the objective of achieving the medium-term target for consumer price index (CPI) inflation of 4 percent within a band of +/- 2 percent while supporting growth.

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

Assessment

Global Economy

The outlook on global growth has improved in recent months, despite the persistence of geopolitical hostilities and the impact of monetary policy tightening by central banks across the world. Nonetheless, global growth is expected to decelerate during 2023. Inflation is exhibiting some softening from elevated levels, prompting central banks to moderate the size and pace of rate actions. However, central banks are reiterating their commitment to bring down inflation close to their targets. Bond yields remain volatile. The US dollar has come off its recent peak, and equity markets have moved higher since the last MPC meeting. Weak external demand in major advanced economies (AEs), the rising incidence of protectionist policies, volatile capital flows, and debt distress could, however, weigh adversely on prospects for emerging market economies (EMEs).

Domestic Economy

The first advance estimates (FAE) released by the National Statistical Office (NSO) on January 6, 2023, placed India’s real gross domestic product (GDP) growth at 7.0 percent year-on-year (y-o-y) for 2022-23, driven by private consumption and investment. On the supply side, gross value added (GVA) was estimated at 6.7 percent.

High-frequency indicators suggest that economic activity has remained strong in Q3 and Q4:2022-23. Rabi acreage exceeded last year’s area by 3.3 percent as on February 3, 2023. Industrial production expanded by 7.1 percent in November, after contracting by 4.2 percent in October. Capacity utilization in manufacturing is now above its long-period average. Port freight traffic, e-way bills, and toll collections were buoyant in December. Purchasing managers’ indices (PMIs) for manufacturing as well as services remained in expansion in January, despite some moderation compared to the previous month.

Domestic demand has been sustained by strong discretionary spending. Urban demand exhibited resilience as reflected in healthy passenger vehicle sales and domestic air passenger traffic. Rural demand is improving. Investment activity is gradually gaining ground. Non-oil and non-gold imports expanded in December. Merchandise exports, on the other hand, contracted in December on weak global demand.

CPI headline inflation moderated to 5.7 percent (y-o-y) in December 2022 – after easing to 5.9 percent in November – on the back of double-digit deflation in vegetable prices. On the other hand, inflationary pressures are accentuated across cereals, protein-based food items, and spices. Fuel inflation edged up primarily from an uptick in kerosene prices. Core CPI (i.e., CPI excluding food and fuel) inflation rose to 6.1 percent in December due to sustained price pressures in health, education, and personal care and effects.

The overall liquidity remains in surplus, with average daily absorption under the LAF increasing to ₹1.6 lakh crore during December-January from an average of ₹1.4 lakh crore in October-November. On a y-o-y basis, money supply (M3) expanded by 9.8 percent as on January 27, 2023, while non-food bank credit rose by 16.7 percent. India’s foreign exchange reserves were placed at US$ 576.8 billion as on January 27, 2023.

Outlook

The outlook for inflation is mixed. While prospects for the rabi crop have improved, especially for wheat and oilseeds, risks from adverse weather events remain. The global commodity price outlook, including crude oil, is subject to uncertainties on demand prospects as well as from risks of supply disruptions due to geopolitical tensions. Commodity prices are expected to face upward pressures with the easing of COVID-related mobility restrictions in some parts of the world.

The ongoing pass-through of input costs to output prices, especially in services, could continue to exert pressures on core inflation. The Reserve Bank’s enterprise surveys point to some softening of input cost and output price pressures in manufacturing.

Taking into account these factors and assuming an average crude oil price (Indian basket) of US$ 95 per barrel, inflation is projected at 6.5 percent in 2022-23, with Q4 at 5.7 percent. On the assumption of a normal monsoon, CPI inflation is projected at 5.3 percent for 2023-24, with Q1 at 5.0 percent, Q2 at 5.4 percent, Q3 at 5.4 percent, and Q4 at 5.6 percent, and risks evenly balanced.

The stronger prospects for agricultural and allied activities are likely to boost rural demand. The rebound in contact-intensive sectors and discretionary spending is expected to support urban consumption. Businesses and consumers surveyed by the Reserve Bank are optimistic about the outlook. Strong credit growth, resilient financial markets, and the government’s continued thrust on capital spending and infrastructure create a congenial environment for investment. On the other hand, external demand is likely to be dented by a slowdown in global activity, with adverse implications for exports.

Taking all these factors into consideration, real GDP growth for 2023-24 is projected at 6.4 percent with Q1 at 7.8 percent, Q2 at 6.2 percent, Q3 at 6.0 percent and Q4 at 5.8 percent, and risks broadly balanced.

The easing of inflation in the last two months was driven by strong deflation in vegetables, which may dissipate with the summer season's uptick. Headline inflation excluding vegetables has been rising well above the upper tolerance band and may remain elevated, especially with high core inflation pressures. Inflation, therefore, remains a major risk to the outlook.

Domestic economic activity is expected to remain resilient aided by the sustained focus on capital and infrastructure spending in the Union Budget 2023-24, even as continuing fiscal consolidation creates space for private investment. While the policy repo rate increases undertaken since May 2022 are working their way through the system, it is imperative to remain alert on inflation to ensure that it remains within the tolerance band and progressively aligns with the target.

On balance, the MPC is of the view that further calibrated monetary policy action is warranted to keep inflation expectations anchored, breakcore inflation persistence and thereby strengthen medium-term growth prospects. Accordingly, the MPC decided to increase the policy repo rate by 25 basis points to 6.50 percent. The MPC also decided to remain focused on the withdrawal of accommodation to ensure that inflation remains within the target going forward while supporting growth.

Dr. Shashanka Bhide, Dr. Rajiv Ranjan, Dr. Michael Debabrata Patra and Shri Shaktikanta Das voted to increase the policy repo rate by 25 basis points. Dr. Ashima Goyal and Prof. Jayanth R. Varma voted against the repo rate hike.

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

 

RBI Governor’s Statement: 8^th February’2023

As I set out the first monetary policy statement of the New Year, I am reminded of the historical significance of 2023 for the Reserve Bank of India. From being a Joint Stock Company, the Reserve Bank was brought into public ownership on January 1, 1949.1 Thus, 2023 marks the 75th year of public ownership of the Reserve Bank and its emergence as a national institution. This is an opportune moment to briefly reflect upon the evolution of monetary policy over this period.

In the two decades after independence, the Reserve Bank’s role was to support the credit needs of the economy under the five-year plans. The following two decades were characterized by bank nationalization in 1969, oil shocks, monetization of large budget deficits, and a sharp rise in money supply and inflation.

Monetary targeting was adopted in the mid-1980s to contain growth in the money supply and curb inflation pressures. Since the early 1990s, the Reserve Bank focused on market reforms and institution building. A multiple-indicator approach was adopted in April 1998 under which a host of indicators were monitored for policymaking. In the aftermath of the global financial crisis and the taper tantrum, as inflationary conditions worsened in India, flexible inflation targeting (FIT) was formally adopted in June 2016 to provide a credible nominal anchor for monetary policy. As we know, the primary objective of monetary policy under the FIT framework is to maintain price stability while keeping in mind the objective of growth.

Coming to present times, the unprecedented events of the last three years have put to test monetary policy frameworks globally. In a very short period, monetary policies across the world have veered from one extreme to the other in response to a series of overlapping shocks. In contrast to the Great Moderation era of the 1990s and the early years of this century, monetary policy was confronted with an unprecedented contraction in economic activity followed by a surge in global inflation. This calls for a deeper understanding of the structural changes in the global economy and inflation dynamics, and their implications for the conduct of monetary policy.

In the current unsettled global environment, emerging market economies (EMEs) are facing sharp trade-offs between supporting economic activity and controlling inflation, while preserving policy credibility. As global fault lines emerge in trade, technology, and investment flows, there is an urgent need to reinforce global cooperation. The world is looking to India, now at the helm of G-20, to energize global partnerships in several critical areas. This reminds me of what Mahatma Gandhi said: “I do believe that…India…can make a lasting contribution to the peace and solid progress of the world.”

Decisions and Deliberations of the Monetary Policy Committee (MPC)

The Monetary Policy Committee (MPC) met on the 6th, 7th, and 8th of February 2023. Based on an assessment of the macroeconomic situation and its outlook; the MPC decided by a majority of 4 members out of 6 to increase the policy repo rate by 25 basis points to 6.50 percent, with immediate effect. Consequently, the standing deposit facility (SDF) rate will stand revised to 6.25 percent; and the marginal standing facility (MSF) rate and the Bank Rate to 6.75 percent. The MPC also decided by a majority of 4 out of 6 members to remain focused on the withdrawal of accommodation to ensure that inflation remains within the target going forward while supporting growth.

Let me now explain the MPC’s rationale for these decisions on the policy rate and the stance. The global economic outlook does not look as grim now as it did a few months ago. Growth prospects in major economies have improved, while inflation is on a descent, though it remains well above the target in major economies. The situation remains fluid and uncertain. Reflecting the recent optimism, the IMF has revised upwards the global growth estimates for 2022 and 2023.3

As price pressures wane, several central banks have opted for slower rate hikes or pauses. The US dollar has retreated sharply from its highest level in two decades. Tighter financial conditions caused by aggressive monetary policy actions, volatile financial markets, debt distress, protracted geopolitical hostilities, and fragmentation continue to impart high uncertainty to the outlook for the global economy.

Amidst these volatile global developments, the Indian economy remains resilient. Real GDP growth is estimated at 7.0 percent in 2022-23, according to the first advance estimate of the National Statistical Office (NSO). Higher rabi acreage, sustained urban demand, improving rural demand, robust credit expansion, gains in consumer and business optimism, and the government’s enhanced thrust on capital expenditure and infrastructure in the Union Budget 2023-24 should support economic activity in the coming year. Weak external demand and the uncertain global environment, however, would be a drag on domestic growth prospects.

Consumer price inflation in India moved below the upper tolerance level during November-December 2022, driven by a strong decline in the prices of vegetables. Core inflation, however, remains sticky.

Looking ahead, while inflation is expected to moderate in 2023-24, it is likely to rule above the 4 percent target. The outlook is clouded by continuing uncertainties from geopolitical tensions, global financial market volatility, rising non-oil commodity prices and volatile crude oil prices. At the same time, economic activity in India is expected to hold up well. The rate hikes since May 2022 are still working their way through the system.

On balance, the MPC was of the view that further calibrated monetary policy action is warranted to keep inflation expectations anchored, break the persistence of core inflation and thereby strengthen the medium-term growth prospects. Accordingly, the MPC decided to raise the policy repo rate by 25 basis points to 6.50 percent. The MPC will continue to maintain a strong vigil on the evolving inflation outlook to ensure that it remains within the tolerance band and progressively aligns with the target.

Inflation is expected to average 5.6 percent in Q4 2023-24 while the policy repo rate is 6.50 percent. Adjusted for inflation, the policy rate still trails its pre-pandemic levels. Liquidity remains in surplus, with an average daily absorption of ₹1.6 lakh crore under the LAF in January 2023. The overall monetary conditions, therefore, remain accommodative, and hence, the MPC decided to remain focused on the withdrawal of accommodation.

Assessment of Growth and Inflation

Growth

Available data for Q3 and Q4 2022-23 indicate that economic activity in India remains resilient. Urban consumption demand has been firming up, driven by a sustained recovery in discretionary spending, especially on services such as travel, tourism, and hospitality. Passenger vehicle sales and domestic air passenger traffic posted robust year-on-year (y-o-y) growth. Domestic air passenger traffic crossed pre-pandemic levels for the first time in December 2022. Rural demand continues to show signs of improvement as tractor sales and two-wheeler sales expanded in December. Several high-frequency indicators (such as Port freight traffic; railway freight traffic; toll collections; E-way bills; diesel consumption; and electricity consumption) are also pointing toward the strengthening of activity.

Investment activity continues to gain traction; Non-food bank credit expanded by 16.7 percent (y-o-y) as on January 27, 2023. The total flow of resources to the commercial sector has increased by ₹20.8 lakh crore during 2022-23 so far as against ₹12.5 lakh crore a year ago. Indicators of fixed investment – cement output; steel consumption; and production and import of capital goods – registered robust growth in November and December. In several sectors such as cement, steel, mining, and chemicals, there are signs that additional capacity is being created in the private sector. According to the RBI’s survey, seasonally adjusted capacity utilization increased to 74.5 percent in Q2 2022-23. The drag from net external demand, on the other hand, continued as merchandise exports contracted in Q3 2022-23.

On the supply side, agricultural activity remains strong with good Rabi sowing, higher reservoir levels, good soil moisture, favorable winter temperature, and comfortable availability of fertilizers. PMI manufacturing and PMI services remained in expansion at 55.4 and 57.2 respectively, in January 2023.

Turning to the outlook, the expected higher Rabi output has improved the prospects of agriculture and rural demand. The sustained rebound in contact-intensive sectors should support urban consumption. Broad-based credit growth, improving capacity utilization, government’s thrust on capital spending and infrastructure should bolster investment activity. According to our surveys, manufacturing, services, and infrastructure sector firms are optimistic about the business outlook. On the other hand, protracted geopolitical tensions, tightening global financial conditions, and slowing external demand may continue as downside risks to domestic output.

Taking all these factors into consideration, real GDP growth for 2023-24 is projected at 6.4 percent with Q1 at 7.8 percent; Q2 at 6.2 percent; Q3 at 6.0 percent; and Q4 at 5.8 percent. The risks are evenly balanced.

Inflation

Headline CPI inflation moderated by 105 basis points during November-December 2022 from its level of 6.8 percent in October 2022. This was due to a softening in food inflation on the back of a sharp deflation in vegetable prices, which more than offset the inflationary pressures from cereals, protein-based food items, and spices. As a result of this earlier-than-anticipated and steeper seasonal decline in vegetable prices, inflation for Q3 2022-23 has turned out to be lower than our projections. Core CPI inflation (i.e., CPI excluding food and fuel), however, remained elevated.

Going ahead, the food inflation outlook will benefit from a likely bumper Rabi harvest led by wheat and oilseeds. Mandi arrivals and Kharif paddy procurement have been robust, resulting in improvement in the buffer stocks of rice. All these developments augur favorably for the food inflation outlook in 2023-24. Considerable uncertainties remain on the likely trajectory of global commodity prices, including the price of crude oil. Commodity prices may remain firm with the easing of COVID-19-related restrictions in some parts of the world.

The ongoing pass-through of input costs, especially in services, could keep core inflation at elevated levels. The commitment to fiscal consolidation that has been carried forward in the Union Budget 2023-24 and the future trajectory of reducing the gross fiscal deficit will engender an environment of macroeconomic stability. This augurs well for the inflation outlook. Further, the low volatility of the Indian rupee relative to peer currencies limits the impact of imported price pressures and other global spillovers.

Taking into account these factors and assuming an average crude oil price (Indian basket) of US$ 95 per barrel, inflation is projected at 6.5 percent in 2022-23, with Q4 at 5.7 percent. On the assumption of a normal monsoon, CPI inflation is projected at 5.3 percent for 2023-24, with Q1 at 5.0 percent, Q2 at 5.4 percent, Q3 at 5.4 percent and Q4 at 5.6 percent. The risks are evenly balanced.

Headline inflation has moderated with negative momentum in November and December 2022, but the stickiness of core or underlying inflation is a matter of concern. We need to see a decisive moderation in inflation. We have to remain unwavering in our commitment to bringing down inflation. Thus, monetary policy has to be tailored to ensure a durable disinflation process. A rate hike of 25 basis points is considered appropriate at the current juncture.

The reduction in the size of the rate hike provides the opportunity to evaluate the effects of the actions taken so far on the inflation outlook and the economy at large. It also provides elbow room to weigh all incoming data and forecasts to determine appropriate actions and policy stances, going forward. Monetary policy will continue to be agile and alert to the moving parts in the inflation trajectory to effectively address the challenges to the economy.

Liquidity and Financial Market Conditions

As we approach the end of 2022-23, it is worthwhile to recapitulate the key developments on the monetary policy front over the last year. After the onset of the war in Europe, which drastically altered the growth-inflation dynamics across the world, including India, we have taken a series of steps in the best interest of the Indian economy.

We accorded primacy to price stability over growth in April 2022; we instituted a major reform in the monetary policy operating procedure through the introduction of the standing deposit facility (SDF); we restored the width of the policy corridor to its pre-pandemic level; we raised the repo rate by 40 bps and the cash reserve ratio (CRR) by 50 bps in an off-cycle meeting in May; we shifted the policy stance to focus on withdrawal of accommodation; we continued the rate tightening cycle in every meeting of the MPC; and we adopted a nimble and flexible approach to liquidity management by conducting both variable rate reverse repo (VRRR) and variable rate repo (VRR) operations as per requirement.

As a result of all these measures, the real policy rate has been nudged into positive territory; the banking system has moved out of the Chakravyuh of excess liquidity; inflation is moderating; and economic growth continues to be resilient.

As I make this statement, system liquidity remains in surplus, though of a lower order compared to April 2022. In the period ahead, while higher government expenditure and the anticipated return of forex inflows are likely to augment systemic liquidity, it would get modulated by the scheduled redemption of LTRO and TLTRO funds during February to April 2023. The Reserve Bank will remain flexible and responsive toward meeting the productive requirements of the economy. We will conduct operations on either side of the LAF, depending on the evolving liquidity conditions.

As part of our gradual move towards normalizing liquidity and market operations, it has now been decided to restore market hours for the Government Securities market to the pre-pandemic timing of 9 am to 5 pm.8 Moreover, as part of our ongoing endeavor, to further develop the government securities market, we propose to permit lending and borrowing of G-secs. This will provide investors with an avenue to deploy their idle securities, enhance portfolio returns and facilitate wider participation. This measure will also add depth and liquidity to the G-sec market; aid efficient price discovery; and work towards a smooth completion of the market borrowing program of the center and states.

The pace of transmission of monetary policy actions to lending and deposit rates has strengthened in the current tightening cycle. The weighted average lending rates (WALR) on fresh rupee loans and outstanding loans increased by 137 bps and 80 bps respectively, during May to December 2022. The weighted average domestic term deposit rate on fresh deposits and outstanding deposits increased by 213 bps and 75 bps respectively.

The Indian Rupee has remained one of the least volatile currencies among its Asian peers in the calendar year 2022 and continues to be so this year also. Similarly, the depreciation and the volatility of the Indian rupee during the current phase of multiple shocks is far lower than during the global financial crisis and the taper tantrum. In a fundamental sense, the movements of the rupee reflect the resilience of the Indian economy.

External Sector

The current account deficit (CAD) for the first half of 2022-23 stood at 3.3 percent of GDP. The situation has shown improvement in Q3 2022-23 as imports moderated in the wake of lower commodity prices, resulting in the narrowing of the merchandise trade deficit. Further, services exports rose by 24.9 percent (y-o-y) in Q3:2022-23, driven by software, business and travel services. Global software and IT services spending is expected to remain strong in 2023.

Remittance growth for India in H1 of 2022-23 was around 26 percent – more than twice the World Bank’s projection for the year. This is likely to remain robust owing to the better growth prospects of the Gulf countries. The net balance under services and remittances is expected to remain in a large surplus, partly offsetting the trade deficit. The CAD is expected to moderate in H2:2022-23 and remain eminently manageable and within the parameters of viability.

On the financing side, net foreign direct investment (FDI) flows remain strong at US $22.3 billion during April-December 2022 (US 24.8 billion in the corresponding period last year). Foreign portfolio flows have shown signs of improvement with positive flows of US$8.5 billion during July to February 6, led by equity flows (foreign portfolio flows are, however, negative during the financial year so far). Net inflows under non-resident deposits increased to US$ 3.6 billion during April-November 2022 from US $ 2.6 billion a year ago, boosted by the Reserve Bank’s July 6th measures. Foreign exchange reserves have rebounded from US$ 524.5 billion on October 21, 2022, to US$ 576.8 billion as on January 27, 2023, covering around 9.4 months of projected imports for 2022-23. India’s external debt ratios are low by international standards.

Additional Measures

I shall now announce certain additional measures.

Penal Charges on Loans

At present, Regulated Entities (REs) are required to have a policy for the levy of penal interest on advances. The REs, however, follow divergent practices in levying such charges. In certain cases, these charges are founded to be excessive. To further enhance transparency, reasonableness, and consumer protection, draft guidelines on the levy of penal charges will be issued to obtain comments from stakeholders.

Climate Risk and Sustainable Finance

Recognizing the importance of climate-related financial risks which may have financial stability implications, the Reserve Bank issued a Discussion Paper on Climate Risk and Sustainable Finance in July 2022. Based on the feedback received, it has been decided to issue guidelines for REs on (i) a broad framework for acceptance of Green Deposits; (ii) a disclosure framework on Climate-related Financial Risks; and (iii) guidance on Climate Scenario Analysis and Stress Testing.

Expanding the Scope of TReDS

For the benefit of MSMEs, the Reserve Bank introduced a framework in 2014 to facilitate the financing of their trade receivables through the Trade Receivables Discounting System (TReDS). It is now proposed to expand the scope of TReDs by (i) providing an insurance facility for invoice financing; (ii) permitting all entities/institutions undertaking factoring business to participate as financiers in TReDS; and (iii) permitting re-discounting of invoices (that is, developing a secondary market in TReDS). These measures are expected to improve the cash flows of MSMEs.

Extending UPI for Inbound Travelers to India

UPI has become hugely popular for retail digital payments in India. It is now proposed to permit all inbound travelers to India to use UPI for their merchant payments (P2M) while they are in the country. To begin with, this facility will be extended to travelers from G-20 countries arriving at select international airports.

QR Code-based Coin Vending Machine - Pilot project

The Reserve Bank of India will launch a pilot project on QR Code-based Coin Vending Machines (QCVM) in 12 cities. These vending machines will dispense coins against debit to the customer’s account using UPI instead of physical tendering of banknotes. This will enhance the ease of accessibility to coins. Based on the learnings from the pilot, guidelines will be issued to banks to promote the distribution of coins using these machines.

Conclusion

As we begin a new year, it is a good time to reflect upon our journey so far and what lies ahead. When I look back, it is heartening to note that the Indian economy successfully dealt with multiple major shocks in the last three years and has emerged stronger than before. India has the inherent strength, an enabling policy environment, and strong macroeconomic fundamentals and buffers to deal with future challenges. I am reminded here of the words of Netaji Subhas Chandra Bose: “……..never lose your faith in the destiny of India”.

Highlights of RBI Governor Das and Dy. Gov. Patra’s comments in the presser and Q&A:

·         Firstly, the Indian economy remains resilient. It has withstood successive global shocks over the last 3 years. Each shock came with unprecedented suddenness and spillovers. Major economies are still reeling under their pressure. However, the Indian economy, amidst all this, remains resilient

·         Second, inflation has shown signs of moderation. I repeat, inflation has shown signs of moderation and the worst is behind us. But there are concerns about core inflation. We cannot take our eyes off inflation

·         Third, we are now witnessing conducive conditions of macroeconomic stability as reflected in moderation in inflation, fiscal consolidation, and the expectation that the current account deficit is likely to narrow in the coming quarters

·         Fourth, the Indian rupee has remained one of the least volatile currencies among its Asian peers in 2022 and continues to be so this year also

·         Fifth, the real policy rate has moved into positive territory, and the banking system has exited from the Chakravyuh of excess liquidity without causing any disruption. Monetary policy transmission is also picking up

·         Sixth, on liquidity, the Reserve Bank will remain flexible and responsive to the requirements of the productive sectors of the economy

·         Seventh and the final point is that we, at the Reserve Bank of India, stand resolute to deal with all future challenges

·         RBI projected higher inflation for H2FY24 due to lower base effects in the corresponding period in FY23

·         MPC decision goes by the majority; although RBI is not providing any forward guidance (like Fed, ECB), RBI has made it clear that RBI will be extremely watchful of the incoming data as well as the inflation outlook and overall economy; RBI will take decision based on that going forward

·         Core service inflation is still elevated with no signs of moderation despite some easing in core goods inflation

·         RBI also watching sequential variations in core inflation closely

·         Banks are now actively mobilizing deposits to keep pace with credit growth

·         The real policy rate is now around +0.90% if RBI’s CPI projection of Q4FY24 CPI +5.6% is taken into account

·         Going ahead, RBI will decide on appropriate levels of the real rate as per evolving growth and inflation trajectory; it may not be in line with pre-COVID levels of around +2.30%

·         RBI is also watching rate actions by Fed as it an effect on INR and imported inflation, but ultimately RBI is taking decisions on domestic macroeconomy factors

·         Indian banking system including NBFCs continues to be robust despite Adani concern

·         RBI does not see a resurgence of inflation in FY24 and accordingly projected +5.3% CPI on an average against +6.5% for FY23

·         Developed economies have a wider gap between the 2% target and current levels of inflation, while India has a comparatively lower gap with 4% targets

·         RBI is not in a pause mode right now, but in a mood of optimism with a hawk’s eye on the core inflation trajectory

·         Indian banks and NBFCs have not lent any significant amount to Adani group against pledging of shares; most of the lending was done as per prescribed rules & regulations against proper business/cash flow analysis and secured against some tangible assets. Thus there is no big risk in the Indian banking system

·         RBI projected lower economic growth in FY24 than in FY23 because of lingering Russia-Ukraine/NATO geopolitical tensions and economic sanctions and resultant weak global trade/exports; in FY23, RBI revised down its GDP growth projection for the same reason

·         RBI will ensure adequate liquidity in the money market by conducting LAF operations on both sides from time to time (absorption/injection) as per evolving situations to make sure uninterrupted lending to the productive sector of the economy while keeping overall liquidity balanced/not too much surplus

·         RBI is now quite concerned about sticky core inflation hovering around +6% for a long time; thus even after +250 bps rate hikes since May’22, RBI is not in a position to declare pause; but RBI is now taking calibrated tightening (smaller hikes) to see the effect of cumulative tightening as there is a policy transmission lag of 10-14 months

·         RBI will go by the majority of MPC decisions although there may be differences and debates

·         Indian banks are very proactive and prudent in pre-provisioning stressed assets for any doubtful account including Adani group, if they think so; there are clear regulatory guidelines

·         RBI is not concerned about liquidity management due to large government borrowings; the Indian money market is now deep enough to absorb such government borrowing and sequentially, the net borrowing increase is not significant also (Rs.11.80T vs 11.08T)

·         Some entities like insurance companies are not permitted to borrow money in the existing REPO market lending & borrowing operations of G-SECs; thus RBI will allow separate borrowing & lending mechanisms for G-SECs which will eventually add more liquidity, efficiency, and proper price discovery/depth in the money market; short selling would be also allowed as currently in the REPO market

·         RBI is hiking rates so that it will bring down excess demand (relative to constrained supply) of the economy and core inflation eventually

·         RBI sees lower core and also headline inflation in FY24 as a result of lower demand (after significant rate hikes) and thus RBI may not continue the tighter monetary policy for a longer time; i.e. RBI may discuss/go for some rate cuts in early 2024

·         Going ahead, RBI may shift to a neutral stance from the removal of accommodation when there is a decisive moderation in inflation and a propensity (a natural tendency) to align with the 4% target; i.e. when RBI is confident inflation/core inflation is going down decisively towards 4% target

·         RBI is not in a position to share/provide Fed/ECB like definitive forward guidance as it will create unnecessary or unreasonable expectations in the market; but, being data dependent, RBI is analyzing all the important incoming economic data and outlook thereof; will take appropriate decisions at appropriate times (to continue hikes or pauses)

Conclusions:

The U.S. economy may be slowing down, but price pressure/core inflation and the labor market are still substantially hot. And the Fed is now clearly preparing the market in a calibrated way for a 5.25-5.50% terminal rate by June’23 and then a pause to assess. Fed will ensure price stability along with financial stability avoiding a hard landing. Fed will keenly watch the core inflation trajectory for Q1CY23 and then make a fresh SEP on 16^th March for the projected terminal rate for 2023 (after reaching +5.00% repo rates).

After Jan’23 blockbuster U.S. job data including hotter than expected monthly wage growths, hotter than expected core inflation, and retail sales coupled with various comments by Powell & Co (synchronized/balancing jawboning), the market is now assuming a higher terminal rate of around 5.25%-5.50% by May-Jun’23 and no cuts in 2023. The market is now discounting itself for much higher expectations of terminal rates.

As per the pre-COVID trend and various comments by Fed Chair Powell, Fed may like to keep the terminal rate at least above 25 bps of average core CPI to have a real positive rate. Fed will consider at least two-quarters of average core inflation in 2023 for its rate actions. After reaching +5.25% by May, Fed may pause if the core inflation trajectory takes a definitive downtrend and falls below +5.00% on a sustainable basis; otherwise, Fed may even go for +5.50% repo rates by June’23.

India’s RBI may also hike +0.25% on 6^th April and further +0.25% in June for a terminal rate of 6.75-7.00% against the Fed’s 5.25-5.50%. India’s core CPI continues to be sticky around +6.00% and thus RBI wants to ensure a real positive rate, by at least +100 bps (restrictive levels) wrt at least core inflation.

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

As per Taylor’s rule, for India:

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

Here for RBI/India:

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

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

As per Taylor’s rule, for the US:

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

Here for U.S. /Fed

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

India also pays almost 45% of its tax revenue as interest on public debt and over 40% on salary & pensions for government employees (including militaries/other agencies). Although a huge pool of government employees is also providing robust consumer spending (discretionary) amid real wage growths, job stability, and family pension security for a lifetime, India needs to control its sticky core inflation for relatively lower bond yield and lower borrowing costs for overall lower cost of living for the masses. Also, India needs to improve its innovation and productivity, which is the ultimate.

But Indian consumer spending is also resilient despite the higher cost of living because almost 30% of the Indian middle-class population, equivalent to the entire U.S. population has stable jobs/income (government and reputed corporate employees), and has adequate real wage growths regularly. Many Indian super riches are now growing rapidly, thanks to the vibrant stock & real estate market and digital ecosystem.

Also, despite DEMO in 2016, the flow of black money in the Indian economy is still robust due to rampant corruption at almost all levels, especially in various infra projects (cut money) and even certain state levels of government employment. Thus, despite higher inflation, higher borrowing costs, and higher cost of living, the Indian consumer spending story is still robust, causing sticky core inflation.

RBI, as a debt manager of the government, will have to also ensure lower borrowing costs by controlling bond yields directly/indirectly. Thus considering all the pros & cons, RBI may also pause after reaching a terminal repo rate of 6.75-7.00% by June’23 and may go for rate cut moves from early 2024, just ahead of a general election in India. On the other side, if Fed continues to hike even after June’23 (most unlikely), then RBI also has no option to follow the Fed and take a terminal rate of 7.25-7.50% by Sep’23. Fed may also go for rate cuts ahead of the Nov’24 U.S. Presidential election with the hope that U.S. core inflation will come down towards the 2% target. But as RBI may be in a position to cut rates earlier than Fed, USDINR may scale 85-90 levels by early 2024; traditionally USDINR always appreciates significantly ahead of any Indian general election to finance unofficial huge election spending of various political parties (Indian black money round-tripping).

Bottom line: Nifty Future: 17570 as of 22/02/23-EOD

Looking ahead, whatever may be the narrative, technically Nifty Future now has to sustain over 17500 for a rebound towards 17650/17875-18075/18150* and further 18225/18275-18335/18450*-18515/18555 and 18950/19025* in the coming days; otherwise sustaining below 17450, Nifty Future may further fall to 17395-17350/17200* and 17075/16640* in the coming days.

 

 

 

 

 

Articles

Comments