RBI holds repo rates, as expected, upgrades growth estimates

8 Dec 2023 , 12:16 PM

What happened in last 2 months since October policy

The monetary policy statement of December 2023 marked the fifth consecutive monetary policy where RBI maintained status quo on rates. The last rate hike was in February 2023 and RBI has been on pause mode since then. One must not overlook the background to this situation. Between May 2022 and February 2023, RBI had hiked repo rates by 250 basis points from 4.00% to 6.50%. In between, there was a negative surprise with inflation spiking to 7.44% for July 2023. However, since then, the consumer inflation has abated and is now down to 4.87% in October 2023, even as November inflation data is still awaited. 

In the last 2 months since the October policy, another big shift was the GDP data. For the second quarter ended September 2023, the real GDP growth came in at 7.6%, nearly 80 bps better than the street estimates. This was largely supported by manufacturing, construction, public utilities, and mining; even as agricultural growth faltered. In the last 2 months, India finds itself in the Goldilocks sweet spot; wherein growth has been much better than expected while inflation has been lower than anticipated. 

US-based macro cues are also changing for the better

Even as the US Fed has maintained pause in three out of the last four policies, some of the data flows from the US have been refreshingly positive. The second estimate of Q3 GDP growth got upgraded by 30 bps to 5.2% in one of the best quarters for the US economy. It also means that hard landing is ruled out and 2023 GDP growth in the US could be better than expected. This is also supported by the fact that PCE inflation has tapered by 40 bps in October to 3.0%, a clear indication of inflation moving towards the 2.0% eventual target.

But the real positive cues from there cues came from market indicators like the CME Fedwatch, US bond yields and the dollar index (DXY). CME Fedwatch is betting on the Fed cutting rates aggressively, while the US bond yields are sharply down from 5.00% to 4.16% in just a little over a month. Even the US dollar index is down from above 106.50 levels to below 103.50 levels, putting less pressure on the rupee. Overall US data looks dovish.

Highlights of the RBI policy statement – December 2023

The December policy was expected to maintain status quo on rates and that is what it did. Here are some key takeaways from the policy statement.

• RBI maintained the repo rates at 6.50% for the fifth policy in succession. The last time the repo rates were hiked was in the February 2023 policy statement. Repo rates had risen by 250 bps between May 2022 and February 2023. Even now the repo rates are a full 135 bps above pre-COVID repo rate levels of 5.15%. On the rates front, there was a unanimous vote as all 6 members of the MPC voted for status quo on repo rates.

   

• While surplus liquidity in the system is not the issue any longer, the RBI has made it clear in the policy statement that it would like to keep the money markets in a slight liquidity deficit. Hence, the RBI has chosen to maintain the stance of the monetary policy as “Withdrawal of Accommodation.” This is more due to the need to keep the money market liquidity at a slight deficit. This got 5 out of 6 votes in favour.

   

• Liquidity management will continue to be central to the RBI actions in the coming weeks as it now strives to keep the financial system at marginal deficit liquidity. Apart from the use of repos and reverse repos to tweak domestic liquidity, the RBI had also had to handle dollar liquidity by selling dollars to prevent a free fall in the rupee. However, with the dollar index (DXY) tapering, that may not be such a serious concern for the RBI. 

   

• On account of the status quo on repo rates at 6.5%, all the pegged rates also stay where they were. The SDF rate (erstwhile reverse repo) stays pegged at 6.25% (25 basis points below the repo rate). At the same time, the Bank rate and marginal standing facility (MSF) rate stay pegged at 6.75% (25 bps above the repo rates).

   

• The big shift happened in the GDP projection of FY24. In the October policy, the RBI had maintained its GDP projection for FY24 at 6.50%. However, in the December 2023 policy, the RBI has raised the GDP projection for FY24 by a full 50 basis points to 7.00%. This is a sharp upgrade and is likely to impel global rating agencies, multilateral agencies, domestic industry bodies and brokerage houses to up their GDP forecasts for FY24. This was necessitated after Q2FY24 GDP came in at 7.6%, sharply higher than the consensus estimate of 6.8%. More importantly, the nominal GDP in Q2 was higher at 9.1%. The GDP thrust came from sectors with strong externalities like manufacturing, mining, utilities, and construction. 

   

• What about inflation forecast? It may be recollected that in the August policy, the RBI had raised its inflation projection for FY24 by 30 bps from 5.1% to 5.4%. This was necessitated by the sharp surge in food inflation. However, in October, the status quo was maintained and even in December the RBI has maintained inflation projection for FY24 at 5.4%. While there are positive cues of Brent Crude falling sharply, the RBI did not cut the inflation estimates due to concerns that food inflation may once again be driven higher due to the prices of onions and other vegetables spiking. This has happened amidst delays in Kharif harvest coming to the market and erratic Rabi output.

   

• The big question as RBI entered into the last monetary policy of 2023 was, whether the RBI was done with rate hikes in this round. The markets were expecting some hint by the RBI on the terminal rates of interest, but there was none forthcoming in the RBI policy statement. However, the broad indications were given in the previous policy that the RBI would not compromise on 4% inflation and would prefer to hold rates at higher levels for longer. For now, the RBI prefers to take policy decisions based on data flows and that is the right way to do it. The only thing one can safely presume at these levels is that even if India is not at peak repo rates, it is certainly very close to peak rates.

When the RBI decided to hold rates in April, it was a bold gambit. RBI did get tested between June and August when inflation had spiked on the back of sub-optimal Kharif output. However, the RBI stuck to its guns and, in retrospect, its stand has been vindicated. Growth is now at a rapid clip and inflation is less than 100 bps away from the long term inflation target. The one thing that the RBI would really focus on now is to handle the spillover effects of global risks and tweaking of domestic liquidity.

RBI holds inflation estimates at 5.4% for FY24

RBI had hiked Inflation estimate for FY24 by 30 bps from 5.1% to 5.4% in the August policy. In October RBI held its inflation estimate at 5.4% and even in December, the inflation estimates for FY24 have been held at 5.4%. In the last 3 months, there has been a sharp fall in food inflation, fuel inflation and core inflation too. In addition, the risk of imported inflation has also come down sharply due to weakening of the dollar index (DXY) with rate hikes in the US looking increasingly remote. Then why did the RBI not cut inflation forecast? Probably, the RBI wants to observe data flows for couple of more months. 

The recent spike in food prices, delayed Kharif harvest and erratic Rabi progress; only adds to the risk of fuel prices rising due to recent OPEC supply cuts. Hence, the RBI needs more data confirmation before it can cut inflation projections. RBI has maintained its inflation projection for FY24 at 5.4%. In terms of next four quarters; the RBI has projected inflation for Q3FY24 at 5.6%, Q4FY24 at 5.2%, Q1FY25 at 5.2%, Q2FY25 at 4.0%, and Q3FY25 at 4.7%. The changes are only marginal compared to the previous policy statement.

 

GDP growth estimates for FY24 upped 50 bps to 7%

With the Q2FY24 GDP growth coming in at 7.6%, an upgrade in growth estimates for FY24 was almost fait accompli. After all, when the real GDP had growth by 7.8% in Q1 and 7.6% in Q2, a full year estimate of 6.5% would have been just too pessimistic. Not surprisingly, the RBI upgraded its full year GDP forecast for FY24 by 50 basis points from 6.50% to 7.00%. There were several positive triggers that led to this upgrade. Despite a late Kharif harvest, nearly 70% of the Rabi sowing has been completed. That should help agricultural output recover in Q3. Core sector (infrastructure) has grown at above 8% for five months in a row, of which two months were above 12%. GST collections per month are now consistently above Rs1.65 trillion, and that is a key high frequency indicator. To add to these factors, FMCG companies are hinting at revival in rural demand while most industries are seeing peak capacity utilization. All these factors have triggered an upgrade to GDP growth.

There is a big domestic demand story playing out, even as global demand has slackened. Bank lending to the commercial sector this year has been Rs17.6 trillion against Rs14.5 trillion last year. The momentum is clearly in favour of domestic industries and domestic consumption driving growth. Also, with the US GDP growth at 5.2% in Q3-2023, the fervent hope is that export demand and tech spending should also see a sharp revival. It is to reflect this sweet spot that the RBI has upped its GDP growth forecast for FY24 from 6.5% to 7.0%. On a quarter-wise basis, the GDP growth is projected at: Q3FY24 at 6.5%, Q4FY24 at 6.0%, Q1FY25 at6.7%, Q2FY25 at 6.5%, and Q3FY25 at 6.4%. While the RBI does not foresee any negative surprises in the next five quarters, it is expected improved growth to get front-ended and also to get back-ended.

What the RBI governor said on liquidity

In the aftermath of the liquidity infusion by the RBI during COVID pandemic, the RBI balance sheet had grown to 28.6% of GDP. That moderated to 23.3% in FY23 and 21.6% in FY24. That is a lot of liquidity unwound by the RBI, at a rapid pace. Since September 2023, the system liquidity has been in deficit, something not seen in 50 months prior to that. However, this deficit is being maintained at a moderate level deliberately to ensure that the trickle down effect of monetary transmission happens. Otherwise, the rate hikes may not really translate into lower inflation. The enhanced spending in the festive season led to currency leakages, which is likely to normalize. That explains why the RBI has persisted with its monetary policy stance as “Withdrawal of Accommodation.”

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 encourage and simplify foreign exchange hedging, the RBI will issue a master circular encompassing exchange traded derivative and OTC derivatives. Heding will also be made easier for smaller exposures. It also plans to add to the operational efficiency.

   

• Web aggregation of loan products, as part of digital lending, will be brought under a comprehensive umbrella legislation and supervision. The focus will be on enhancing transparency, ensure customer focus and enable borrowers to make informed choices.

   

• With the rapid growth in UPI transactions in India, RBI proposes to enhance limits for various transactions. Payments by UPI to hospitals and educational institutions will see the limits enhanced from Rs1 lakh to Rs5 lakh. Additional factor authentication (AFA) for recurring UPI transactions will see exempt limit upped to Rs1 lakh from Rs15,000.

   

• With the rising need for financial players to store and process mountains data, the RBI is planning a central cloud repository for all such data in a secured place. The RBI cloud facility will enhance the security, integrity, and privacy of such critical data.

   

• Fintechs are seeing rapid change and complexity with the use of distributed ledge systems, blockchain, artificial intelligence and machine learning. A repository of best practices will be created to keep the industry abreast of the latest changes in Fintech.

The December monetary policy was largely along expected lines in terms of repo rates, inflation projections and GDP growth projections. We will get a lot more clarity when the minutes of the MPC are published on December 22, 2023. The next policy statement on February 06-08, 2024 could be interesting as it will come in the immediate aftermath of the last Union Budget of the incumbent government.