RBI holds repo rates at 6.5% in June, lowers inflation forecast

When the RBI announced its last policy statement in April 2023, it had surprisingly decided to hold repo rates at 6.5%. At that time, the RBI governor had underlined that it was merely a pause and not the end of the rate hike cycle. However, several shifts have happened since then. The US Fed itself has changed its stance and is now veering towards status quo in June 2023, which could be the first rate hold decision since March 2022. Also, the banking crisis has been a very localized affair in the US and has hardly had any contagion effects. But the bigger triggers between April and June came from within India.

Consumer inflation in India dipped to 4.7% while the GDP growth stayed robust at 7.2% for FY23, despite the RBI tightening by 250 basis points between May 2022 and February 2023. For the RBI, the April decision to hold rates turned out to be a very good decision in retrospect. Not only did it assuage the industry bodies about cost of funds, but also ensured that consumer inflation was unperturbed and the impact on GDP growth was almost minimal. In this background, the RBI had little incentive or justification to tinker with rates in June. The Bloomberg forecast had a 100% bet on status quo on rates.

Highlights of the RBI policy statement – June 2023

After the surprise of April, the status quo on rates in June was widely expected. But don’t miss the fine print, which we will deal with later.

• RBI maintained repo rates at 6.50% in the June 2023 policy. Repo rates were already up 250 bps from the lows of May 2022 and a full 135 bps higher than the pre-COVID repo rate of 5.15%; despite the pause since April 2023. The vote was unanimous.

   

• The RBI stance stays focused on withdrawal of accommodation; which was apparent considering the surplus liquidity in the system to the tune of more than Rs2 trillion. MPC members voted 5:1 in favour, with only Jayanth Varma preferring a neutral stance.

   

• What does this status quo mean for the linked rates. The SDF rate stayed pegged at 6.25%; pegged 25 basis points below the repo rate. Bank rate and marginal standing facility (MSF) rates stay put at 6.75%, pegged 25 bps above repo rates. 

   

• In the April policy, the RBI governor had cautioned that the status quo decision was a pause and not a halt to rate hikes. That was missing in the June policy. However, the RBI governor did rule out any expectations of a rate cut in the near future.

   

• RBI held its GDP projection for FY24 at 6.5%, despite the better than expected GDP performance of 7.2% in FY23. RBI has upgraded GDP for Q1 and Q2 but cut GDP forecast for Q3 and Q4, resulting in a net neutral position. Global headwinds are still a concern.

   

• On the inflation front, the overall expected inflation for FY24 was cut by 10 bps from 5.2% to 5.1%. While the RBI expects lower inflation in Q1 and Q2, it expects the inflation to stay at the same level in Q3 and Q4. Hence overall impact is just about marginal.

   

• It is hard to fathom if 6.5% is the terminal repo rate or the RBI has something higher in mind. However, the RBI governor cautioning the market not to expect rate cuts is an indication of the reality that rate hikes maybe off the agenda for now.

In a sense, the RBI has been rather lucky. Its decision to hold rates in April was rather bold, but it paid off. The pressure on balance sheets have reduced and inflation has fallen anyways. The GDP for FY23 has also been flattering. In the absence of fresh inflationary triggers, rates may peak at these levels. The debate on rate cuts may be some time away.

Four things the RBI governor hinted at

As much as the policy statement and the regulatory policy update matter, it is the speech of the RBI governor that gives away the real hints on monetary policy. This time around, there were 4 key hints coming from the RBI governor. Firstly, rate cuts are not on the agenda till the consumer inflation decisively settles at or below the 4% mark. Secondly, the governor has hinted at a greater focus on liquidity. Thirdly, with rates stabilizing, the focus shifts to managing liquidity and for that commercial banks have been provided greater leeway. While the RBI remains positive on the domestic demand drivers, it still remains sceptical about how global demand would pan out in the event of a global slowdown. That is the reason, the RBI is still cautious on its growth projections for FY24. Lastly, the RBI has tacitly laid down its conditions for rate cuts. There must be a durable disinflation in core inflation to well below the 5% mark on a sustainable basis.

Inflation for FY24 at 5.1%; GDP growth at 6.5%

Inflation estimate for FY24 has been lowered by another 10 bps from 5.2% to 5.1%. It had been lowered by 10 bps in April too. The RBI expects toning down of wheat prices with arrivals in the mandis. However, Kharif inflation remains a challenge with the monsoons getting delayed and a less than normal monsoon forecast. RBI is now focused on sustainable disinflation in core prices. The break-up of 5.1% retail inflation for FY24 is as under: Q1FY24 at 4.6%, Q2FY24 at 5.2%, Q3FY24 at 5.4% and Q4FY24 at 5.2%. while the RBI has lowered its inflation estimates for Q1 and Q2, it has retained its inflation forecast for Q3 and Q4.

However, RBI has retained its GDP growth estimate for FY24 at 6.5%, which is already higher than the World Bank estimates. The growth projections are largely predicated on a better than expected Rabi crop this season, which would give a big boost to rural incomes and rural consumption. The reason for staying neutral on GDP projections is that RBI is confident of domestic demand and growth but expect an economic slowdown globally to impact export demand. Here is the break-up of FY24 GDP growth of 6.5% quarter-wise. GDP growth is projected at: Q1FY24 at 8.0%, Q2FY24 at 6.5%, Q3FY24 at 6.0% and Q4FY24 at 5.7%. while the RBI has upgraded growth forecasts for Q1 and Q2, it has cut its growth forecast for Q3 and Q4. That explains the overall neutrality in GDP projections for FY24.

Key policy shifts announced by RBI, outside MPC ambit

RBI monetary policy once again went beyond monetary numbers to signal a shift at a policy level. Here are some of the key announcements.

• To facilitate more adept liquidity management, RBI has given more powers to commercial banks. Now banks can set their own borrowing limits subject to the overall prudential conditions laid down.

   

• The RBI has now permitted and put in place a regulatory framework for default loss guarantee arrangements in digital lending. This will enable a balance between innovation and the need for prudential risk management.

   

• RBI plans to expand the scope and reach of e-RUPI vouchers. This e-voucher rides on the UPI platform. Now, the RBI plans to allow non-banks to also issue prepaid e-RUPI vouchers as well as on behalf of individuals. 

   

• RBI will allow the issue of RuPay prepaid forex cards by banks in the light of its growing acceptance. It would be compatible with ATMs, POS machines and online merchants overseas. This is in the light of increased global acceptance of RuPay cards.

RBI has looked at June as a stop-gap policy before a more decisive policy once the Kharif data starts rolling out. The gist of the policy is that we may have seen peak rates, although rate cuts may still be some time away. Inflation remains a key challenge for the RBI, but we would get more clarity when the minutes of the MPC are published on 22nd June. The next policy statement on 10th August 2023 could be a lot more conclusive.