The RBI raised policy rate by 25 basis points to 6.5%, in line with expectations. However, contrary to expectations, it did not provide any explicit forward guidance on policy direction, and yields rose. RBI introduced growth and inflation estimates for FY24 at 6.4% and 5.3% respectively. Analysts at IIFL Securities feel that FY24 estimates may see downgrades, when lag effects of policy rate hikes around the world, take effect. They continue to expect that RBI will pause in its next meeting, given the unexpectedly rapid fall in sequential inflation. Further, it is worthwhile to note the growing dissent amongst MPC members, with two external members already calling for a pause as well as change in stance. Expect pivot soon.

Policy announcements in line with expectations

RBI MPC hiked policy rates by 25 basis points (4:2 majority) to 6.5% — in line with IIFL/consensus expectations. Accordingly, SDF stands adjusted to 6.25% and MSF rate to 6.75%. There was no change in CRR rate. The central bank maintained its current stance of withdrawal of accommodation (4:2 majority) — a section of market was expecting a change to neutral. Stance was maintained, given that adjusted for 1 year forward expected inflation (5.6%), the policy rate still trails its pre-pandemic levels with liquidity still in surplus.

Optimistic on growth while pessimistic on inflation

RBI introduced real GDP growth for FY24 at 6.4%, in line with base case laid by the Economic Survey. Quarterly breakup: 7.8% (Q1FY24), 6.2% (Q2FY24), 6% (Q3FY24) and 5.8% (Q4FY24). Analysts at IIFL Securities see risk to FY24 growth numbers, as global slowdown led by monetary tightening impacts external demand, delays investment pickup and pent-up effects post COVID normalize. FY23 GDP growth at 7%, as per NSO’s estimate, exceeds RBI’s estimate of 6.8% in the last meeting and looks a bit stretched.

Average inflation for FY24 at 5.3% seems pessimistic on the other hand, with sequential momentum slowing down considerably. Quarterly breakup: 5.0% (Q1FY24), 5.4% (Q2FY24), 5.4% (Q3FY24), 5.6% (Q4FY24). FY23 average inflation has been revised downwards marginally to 6.5% from 6.7% earlier, due to favorable inflation prints in the past couple of months.

Inflation moderating on sequential basis; oil prices under control

We are witnessing rapid fall in sequential, seasonally adjusted inflation – US headline and core inflation below 3% on 3mma SAAR basis. For India also, headline inflation is at 3% while WPI inflation is negative; similar trends expected in EU. For US, replacing the lagging indicator Shelter with an average of home price and rental real-time indices, yields a startling near-zero figure. Further, RBI has assumed oil at $95/bbl., but Brent has been unable to breach the $90/bbl mark, despite the EU ban and China re-opening. CRB food index is down 12% from peak and a good Rabi harvest provides further cushion.

Explicit forward guidance missing, but an early pause still on cards

RBI did not provide any forward guidance on policy direction, which left the market puzzled and hence, yields spiked by 5-10 basis points across the curve. However, given the current inflation momentum, analysts at IIFL Securities feel it is likely that a couple of benign inflation prints, some easing in core inflation, and a pause by RBI — could follow in the next meeting. Further, it is worthwhile to note the growing dissent amongst MPC members, with two external members already calling for a pause as well as change in stance.

Expect steady long-term yields, INR

Long-term rates should find support from fiscal consolidation as well as a minor rise (6.5% YoY) in market borrowings announced in the FY24 budget. Further, as inflation continues to recede globally and risk-on sentiment improves, FII flows to EMs and India should stabilize. With RBI’s active intervention, analysts at IIFL Securities see INR to stay stable within 81-84/USD. Possible India inclusion in GBIs in 2024, could be the icing on the cake.

When the RBI Monetary Policy Committee (MPC) announced the first policy of calendar 2023 on 01st February, there was hardly any element of surprise in the announcement. The MPC raised the rates by 25 basis points to 6.50%. With the latest rate hike in February, the RBI MPC has now hiked the repo rates from 4.00% to 6.50% between May 2022 and February 2023. This spike in rates took the SDF (special deposit facility) up to 6.25%. This is pegged 25 bps below the repo rate and is the new proxy for the reverse repo rate. Apart from that, the bank rate and marginal standing facility (MSF) rate, pegged 25 bps above the repo rate, now stands at 6.75%. But the real gist of the policy lies in the outlook.

The MPC rate stance cannot be seen in isolation. It has to be seen in the light of the data flows on CPI inflation and IIP. While IIP is in positive territory now, the CPI inflation for January 2023 has bounced back sharply to 6.52%, after being below 6% for two months in a row. This now brings us to the debate on the outlook for the rates. While voting for the MPC resolutions, there were 2 voices of dissent. Prof Jayant Varma and Dr Ashima Goyal voted against the resolution to hike rates by 25 bps. They favoured status quo on rates to ensure that the GDP recovery impetus was not impaired. While Goyal and Varma want to call off rate hikes for now, the other 4 members were unwilling to let the inflation guard down. With inflation sharply higher in January, rate outlook may veer towards the majority view. 

Shashank Bhide prefers to prepare for return of cyclical inflation

“Persistence of core inflation at a high level is a crucial concern at this stage. It is important to reduce the demand side pressures on inflation and bring the inflation expectations of the various stake holders closer to the policy target to sustain the growth momentum”.

An important point made by Dr Bhide is of the cyclical nature of food inflation. In November and December, the fall in inflation was largely driven by lower vegetable prices. However, that is cyclical and seasonal in nature because other items like milk and cereals continue to remain under pressure. He expects cyclical inflation to return once the seasonality is factored. In a sense, that was borne out by the January CPI inflation data.

Bhide has rightly pointed out that the real pressure comes not from headline inflation but with core inflation persisting above 6%. Unlike in the US, where core inflation has also come down in tandem with food and fuel, the core inflation in India remains sticky. Bhide feels, the momentum of rate hikes must be maintained for now to avoid demand side pressures emerging. Bhide voted for a 25 bps rate hike and withdrawal of monetary accommodation.

Ashima Goyal feels that high inflation has not persisted like the 1970s

“Since there are still little signs of wage or demand-led second round effects on inflation, core inflation may soften over the year. There are signs of the latter in some core components like transport, textiles, recreation and amusement services”.

Goyal has been one of the dissenting members in the MPC. According to her, the analogy of the 1970s is no longer relevant since inflation has not persisted unlike in that period. According to Goyal, the US economy managed to survive extreme hawkishness only due to strong output and stronger than expected labour data. However, in the Indian context, it may not be too wise to persist with such an experiment of hawkishness for too long.

Goyal has pointed out that in the Indian context, the real rates are already in the positive and repo rates are now 135 bps above the pre-COVID rate. Rates are already at a stage wherein further rate hikes could increasingly start hitting growth. Ashima Goyal has, therefore, called for a pause to ensure that the growth levers are not damaged. She has suggested an open and data driven approach to rate hikes from here on.

Jayant Varma warns not to overshoot on the upside

“In the second half of 2021-22, monetary policy was complacent about inflation, and we are paying the price for that in terms of unacceptably high inflation in 2022-23. In the second half of 2022-23, monetary policy has become strangely complacent about growth”.

Varma points out the classic dilemma in monetary policy that the central bank may end up with. For instance, despite exhortations, the RBI had not raised rates in the previous year and is now going overly aggressive on rate hikes this year. Like Goyal, Prof Jayant Varma also voted against the decision to hike rates and additionally voted against the decision to withdraw the accommodative monetary policy stance.

According to Varma, the reality of the current situation is falling inflationary expectations and rising growth concerns. The policy stance must reflect that. He feels that the current repo rate of 6.50% (after the Feb hike) overshoots the policy rate needed for price stability. Varma warns that India may have to pay the price in the form of unacceptably low growth in the fiscal year 2023-24.

Rajiv Ranjan highlights effect of budgetary focus on capex

“I am convinced about the strength of Indian economy reflected in (i) HF indicators; (ii) resilient domestic demand; (iii) budgetary focus on capex; (iv) sound health of corporates and banking; (v) improving external sector indicators; and (vi) depth of financial markets”.

Rajiv Ranjan has underlined that the entire debate on hawkishness versus dovishness can be explained by looking at one factor i.e. the strong budgetary focus on capex. The 33% higher capex supported by strong high frequency indicators as well as robust growth in the profits of banks shows that the growth narrative is still impressive. In this background, Ranjan prefers to focus on policy continuity rather than disrupting the current monetary thinking.

Michael Patra suggests “foot on the brake” monetary policy

“The fight against inflation is complicated by the global outlook. There is some consensus growing around a milder slowdown than earlier feared, although geographical disparities complicate the prognosis”.

Patra has also voted for continuity by hiking the rates by 25 bps. He has also underlined that the need of the hour was to ensure that inflation was kept in check. More importantly, the RBI had to be seen as fighting inflation and any laxity would again raise inflation expectations. However, Patra underlined the need to be flexible and keep a foot on the brake so as to change stance if data showed a structural shift.

RBI Governor says, inflation still way above targets

“Global economic outlook has improved since December 2022. Inflation in major countries has eased in recent prints but remains significantly above their respective targets”.

According to RBI governor, monetary policy must not lose sight of the fact that inflation in India is still 200-250 bps above the median target of 4%. Das has also underlined that lower inflation will directly add to real GDP growth and make up for any tightness lag on growth. However, Das refrained from giving any forward guidance and suggested he would prefer to be data driven, while remaining hawkish for now.

The moral of the MPC minutes is that the committee still remains in hawkish mode, but the votes are gradually shifting. Going ahead, one can expect more rigorous data driven decisions on the rate trajectory. For now, the MPC retains its hawkish tilt.