Will the RBI shift or will it be status quo in August 2023 policy?

8 Aug 2023 , 11:35 AM

The 3-day meeting will culminate in the monetary policy statement issued by the RBI governor on behalf of the MPC. First, a brief background of how the repo rates have panned out in India over the last 15 months. Between May 2022 and February 2023, the RBI hiked repo rates by 250 bps from 4.00% to 6.50% to contain rampant consumer inflation. However, in the subsequent MPC meetings in April and June 2023, the RBI has opted to maintain status quo on rates. Repo rates have been standing at the 6.5% levels for the last 6 months. What has changed in August 2023?

Inflation is the real debate this time around

In fact, a number of things have changed between April and June in terms of domestic inflation outlook and the real rate differentials between the US and India. Let us look at inflation first. In May 2023, India consumer inflation stood at 4.25% (just 25 bps short of its inflation target of 4%), while US consumer inflation had stood at 4% (200 bps short of its inflation target of 2%). In June 2023, India inflation spiked to 4.81% while US inflation fell further to 3%, both in terms of consumer inflation and PCE inflation. That has pushed the US close to its inflation target, while India has moved farther from its inflation target. 

That creates a conflict on real rates for India. Secondly, India has seen a spike in food inflation in the last 2 months, as is evident from the spike in the prices of cereals and vegetables. It was a combination of delayed monsoons followed by erratic flooding. The result has been a spike in food inflation, which is the biggest item in the CPI inflation basket in India. The other risk is rising Brent crude prices, which is now closer to $86/bbl. That threatens to revive the spectre of fuel inflation. Needless to say, core inflation remains sticky. This raises some critical questions for the August 2023 monetary policy.

Will the RBI tinker with rates?

That remains the million dollar question. If one reads the minutes of the June policy, the 3 RBI members of the MPC continue to remain hawkish about rates and sceptical about inflation coming down rapidly. Interestingly, the market is pencilling in a 50% probability of 25 basis points (bps) hike between the August and October 2023 MPC meetings. However, when it comes to rate action, it will be the language of the MPC, rather than the actual rate action that will matter. The general consensus is of an extended pause by the RBI even in the August policy, but it is very likely that the RBI could give a more hawkish guidance on rates for the October policy. Also, the divergence that existed among the MPC members could abate and we could see a combined and consensual attempt at reducing inflation.

Will the RBI change the stance of the policy?

Currently, the monetary stance of the MPC has been enunciated as follows, “The MPC decided to remain focused on withdrawal of accommodation to ensure that inflation progressively aligns with the target while supporting growth.” In the past, MPC members like Jayanth Varma had objected to this stance being out of sync with reality. The question is whether the stance will now turn more dovish or more hawkish? For now, it is likely to remain neutral as the RBI has very few reasons to change the stance. 

Dovishness is ruled out when inflation is rising rapidly. Also, too much hawkishness may spoil the growth story. Withdrawal of accommodation speaks less about rates and more about liquidity. Also, the cancellation of the Rs2,000 denomination notes has added to the banking liquidity by nearly Rs3 trillion. Under these conditions, withdrawal of accommodation remains the best bet for the RBI MPC to focus on. The stance looks very unlikely to change.

Food Inflation versus Core inflation – what will be the focus?

Food inflation will obviously be the major focus for the MPC considering its predominant weight of nearly 46% in the CPI basket. Also, it is the food items like vegetables and cereals that are driving inflation higher due to supply chain constraints. Most of the policy measures with respect to managing food inflation have to do with supply side measures and less to do with tinkering with rates. However, the RBI is also likely to keep track of core inflation, which is the stickier of the two. 

Core inflation (ex-food and fuel) tends to be more structural in nature and that has not come down in sync with food and fuel inflation in the past. Also, the RBI will have to handle both food and core inflation if it has to manage inflation expectations more effectively. After all, it is inflation expectations that actual drive the future trajectory of inflation in India.

Will the RBI estimates of GDP for FY24 change?

For FY24, the RBI has projected full year GDP growth of 6.5%. This comprises of 8% growth in Q1, 6.5% growth in Q2, 6.0% growth in Q3 and 5.7% growth in Q4. Some of the multilateral agencies like the IMF and even rating agencies like Fitch have upped the GDP estimates for India in FY24. However, the RBI estimates were already at a higher plane compared to other estimates. 

Also, the RBI would be wary of the fact that if the global economy does slow down eventually, then the impact on Indian exports and, therefore on the manufacturing and services GDP could be quite significant. We have seen signals of that happening over the last few months with services trade surplus already at a multi-quarter low. While the RBI may not cut the GDP estimates, it is also unlikely to hike the estimates. At best, there is likely to be status quo on the 6.5% GDP growth estimate for FY24.

Will the RBI estimates of CPI Inflation for FY24 change?

For the full year FY24, the RBI has projected CPI inflation at an average rate of 5.1%. This comprises of CPI inflation rate of 4.6% in Q1, 5.2% in Q2, 5.4% in Q3 and 5.2% in Q4. Here, the RBI is very likely to up the inflation target for FY24. The CPI inflation had spiked to 4.81% in June 2023 and for July and August, most economists polled are looking at CPI inflation getting closer to the 6% mark. That is, incidentally, the upper tolerance limit of the RBI with reference to inflation. There are couple of headwinds on the inflation front.
Firstly, the combined impact of delayed monsoons and the deluge is likely to be much sharper on food prices this time around. Also, the acreage of Kharif is likely to be lower this time around, although we will get a clear picture only when the stocks start coming into the mandis. Food inflation is expected to be persistent this time around. Also, fuel inflation could also go up due to the surge in crude to $86/bbl. If you combine fuel and food, they have strong externalities and also impact core inflation in multiple ways. RBI would want to send a message that markets should be prepared for higher inflation. That would be best achieved by hiking the inflation target for FY24.

Will the RBI provide guidance on timing of rate cuts?

Even prior to the recent spike in inflation, the RBI had already hinted that rate cuts were ruled out before the first half of FY25. That is still a good 8 months away. However, with the recent spike in food inflation and growth still robust, the RBI may even look to extend the pause rather than embark on rate cuts. As the RBI has underlined in the past, it would still be focused on data rather than taking a futuristic view on rates or providing guidance. However, rate cuts would certainly not be on the mind of the MPC at a time when the primary focus would be to curb inflation within manageable levels. Any talk of rate cuts or guidance on FY25 rate levels are almost ruled out at this juncture.

To sum it up, the RBI is likely to keep status quo on rates but hike the inflation assessment for FY24. That would be set the groundwork for a rate hike later this year. For now, growth remains strong supported by government capex support. For now, the RBI would just be data driven and take each policy as it comes.