RBI holds repo rates at 6.5% in October, shifts focus to liquidity

6 Oct 2023 , 01:33 PM

Build-up to the October 2023 monetary policy

October 2023 marks the fourth consecutive monetary policy where the RBI maintained status quo on raters. The last rate hike was in February 2023 and since the RBI maintained status quo on rates in April, June, August and now in October tool. It must be remembered that between May 2022 and February 2023, the RBI had hiked repo rates from 4.00% to 6.50%, a spike of 250 basis points in a span of 9 months. However, the RBI has maintained status quo since then; despite the consumer inflation spiking to 7.44% for July 2023 and 6.81% for August 2023. The argument of the MPC (Monetary Policy Committee) of the RBI was that food inflation had tapered in August and is likely to taper further in September. In his post policy speech, RBI Governor also highlighted that during this period of rising food inflation due to delayed monsoons and unseasonal rains, the core inflation had been on a consistent downtrend. The coming week will also mark the total withdrawal of the I-CRR (incremental CRR) introduced in the August policy to absorb surplus liquidity.

US bond yields and dollar index, the new policy narratives

The RBI also opted to maintain inflation and GDP growth at the same rate as it had held I August 2023, but that was not the point. The point was what would the RBI do in the face of high inflation in India, sustained hawkishness of the US Federal Reserve and the persistent appreciation in the US bond yields to a 17-year high of 4.8% and dollar index (DXY) above 107. The real risks to the RBI policy today are not so much internal; as they are external. The risks stem from factors like the likely spill off impact of rising US bond yields, imported inflation due to weakening USDINR and the demand impact of a possible slowdown. It is in this light the MPC decided it may be inappropriate to hike rates. It now looks like even the RBI may define hawkishness as sustained pause in rates at higher levels, rather than rate hikes. One thing is apparent; that rate cuts are very unlikely in the foreseeable future. The RBI governor may not have said that explicitly, but his post policy conference had enough hints on how the RBI will play the hawkishness card going ahead.

Highlights of the RBI policy statement – October 2023

The October 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 fourth policy in succession. Repo rates have risen by a full 250 bps between May 2022 and February 2023. Even now the repo rates are a full 135 bps above the pre-COVID repo rate of 5.15%. All the 6 members of the MPC voted in favour of status quo on repo rates at 6.50%.

   

• It was already clear that with the surplus liquidity in the system due to the I-CRR withdrawal, Rs2,000 note cancellation and advance taxes; the focus would continue to be on withdrawal of accommodation. However, the vote for the monetary stance was not unanimous since Jayanth Varma once again felt that that the withdrawal of accommodative stance was not in sync with the core monetary intent of the RBI.

   

• Liquidity management will be central to the RBI actions in the coming weeks due to the combined liquidity impact of note cancellation, advance taxes and I-CRR withdrawal. In addition, the RBI has regularly intervened in the dollar market by selling spot dollars to defend the rupee. That is also adding to the rupee liquidity in the system.

   

• Due to the status quo on repo rates, 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). On the other hand, the Bank rate and marginal standing facility (MSF) rate stay pegged at 6.75% (25 bps above the repo rates).

   

• GDP projection for FY24 was held at 6.5%, despite the Indian economy reporting GDP growth at 7.8% of GDP for the fiscal year FY23. That is not surprising, considering that the prospects of the global economy still remain hazy due to the persistent rise in rates globally, sticky inflation in Europe and the banking crisis in the US with possible negative ramifications on the bond portfolios of banks due to rising interest rates. 

   

• After raising the inflation projection in August by 30 bps from 5.1% to 5.4%; the RBI has rightly decided to maintain its inflation forecast for FY24 at the same level of 5.4%. While food inflation and fuel inflation have been global concerns, the RBI governor did speak of green shoots. Food prices were cyclical and Kharif acreage this year is better than last year. In addition, Brent crude prices have started correcting and the fears of a global slowdown and a hardening dollar will keep a lid on Brent crude rates. 

   

• The MPC did not give any hint on the terminal repo rates; and that is not surprising considering the ambivalent situation. However, there were two indications coming in the RBI governor speech. The first indication was that RBI would not compromise on its 4% inflation goal or its avowed goal of managing inflation expectations. Secondly, going ahead, the definition of hawkishness would be less about raising rates and more about holding rates on pause mode at elevated levels for a longer period of time. In short, India may not be at peak repo rates, but certainly very close to peak rates.

In retrospect, the decision by the RBI to hold rates in April, and sustain the move till October was bold and fraught with risks. Growth has revived as evident from the high frequency indicators like GST collections, core sector growth, e-way bills and freight movement. Food inflation would have spiked irrespective of the RBI hiking rates. The focus now shifts more towards liquidity and global risks.

Global risks and Liquidity: the 2 point program

A quick reading of the RBI monetary policy statement underlines that global risks are the real worry for the RBI. That was underlined several times in the RBI governor’s post-policy conference. Today, global risks are not just about crude prices or about global growth. They are the fundamental factors in the global story. There are more concerns at an indicator level. For instance, the US bond yields on the 10-year benchmark touched a 17-year high of 4.8%. It is not just the level, but the spike in the last few weeks that is disconcerting. The other factor is the dollar index (DXY) spiking to above 107 in this week. This is only the third time in the last 40 years that the dollar has gone above the 107 mark. That is a signal of dollar strength and that has implications for imported inflation into India, Indian exports and the portfolio dollar returns of foreign portfolio investors. 

From ensuring surplus liquidity the RBI is gradually shifting its stance to keeping a check on liquidity. Too much liquidity in the system can not only distort bond yields across maturities, but also neutralize a lot of the efforts that the RBI is putting into curbing inflation. However, September had seen tightening of liquidity due to I-CRR and advance tax outflows. This has now been controlled due to the phased withdrawal of I-CRR and the liquidity in the banking system from the note withdrawal. Too much liquidity also has a risk in that banks prefer to place the excess liquidity in SDF rather than lending in the VRRR market. That distorts money market volumes. Hence RBI will focus on keeping the liquidity at a level that ensures financial stability without distortions in the money market. 

Status quo on Inflation and GDP estimates for FY24

After the RBI had hiked Inflation estimate for FY24 by 30 bps from 5.1% to 5.4% in the August policy, it has decided to maintain inflation estimates at 5.4% for FY24 in the October policy statement too. While the inflation risks from strong dollar and crude prices still persist, the RBI believes that food inflation has started tapering and should normalize in the next couple of months. Also, the crude prices should be capped due to slowdown fears and dollar strength. Since core inflation is also trending lower, the headline inflation has been maintained at 5.4% for FY24. In terms of next four quarters; the RBI has projected inflation Q2FY24 at 6.4%, Q3FY24 at 5.6%, Q4FY24 at 5.2% and Q1FY25 at 5.2%. The changes are only marginal compared to the previous policy statement.

In addition, the RBI has also retained its GDP growth estimate for FY24 at 6.5%, which is already higher than the World Bank estimates. As a result, the RBI has not hiked its estimates despite the World Bank and Fitch hiking the GDP estimates. The growth projections are predicated on improved Kharif acreage, better than expected Rabi crop, revival in rural demand and the lag effect of the government boost to infrastructure spending. RBI has held its FY24 GDP forecast at 6.5% for the fiscal year. On a quarter-wise basis, the GDP growth is projected at: Q2FY24 at 6.5%, Q3FY24 at 6.5%, Q4FY24 at 6.0% and Q1FY25 at 5.7%. The RBI has also maintained all its quarter estimates intact. That explains the status quo in GDP projections for FY24. It does not foresee any negative surprises.

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.

• There is a draft paper under process to tweak the extant regulatory framework for project finance. The idea is to harmonize it across all regulated entities. This pertains to prudential norms with respect to income recognition and asset classification.

   

• Currently, the credit risk transfer mechanisms only for upper level NBFCs (NBFC-UL). To make risk management more effective, the RBI is planning a detailed framework to extend this risk transfer mechanism to NBFCs is middle and lower level too.

   

• The RBI also proposes an omnibus SRO framework for regulated entities. Self-regulatory organizations (SROs) are an important first level regulator and can play a big part in spread the liability of managing risk in distributed markets. This framework will include SRO eligibility norms, objectives functions and governance standards.

   

• Under the Payment Infrastructure Development Fund (PIDF) scheme, the RBI now plans a massive expansion of the financial inclusion scheme. This includes a big boost to deployment of emerging modes of payment acceptance like soundbox devices, Aadhar Enabled biometric devices and others; with focus on smaller towns and villages.

The August policy was an affirmation that the RBI was willing to take the side of growth in the macroeconomic debate. To a large extent it has been successful and that trend has continued in the October policy also. We will get a lot more clarity when the minutes of the MPC are published on October 20, 2023. The next policy statement on December 08, 2023 could see a lot more clarity on the RBI stance on rates.