RBI holds repo rates at 6.5%; targets 4% headline inflation

5 Apr 2024 , 02:23 PM

WHAT HAS CHANGED SINCE THE FEBRUARY 2024 MONETARY POLICY

For the seventh time in a row, the RBI held repo rates at 6.5% in the April 2024 monetary policy. It may be recollected that the RBI had hiked rates by 250 basis points between May 2022 and February 2023. However, that was the last rate hike and since then, the rates have been on status quo. There have been several changes between the last policy in February and the current policy in terms of fresh data flows. The big news was the GDP growth estimates for the third quarter of FY24, which was put out on the last day of February. The MOSPI surprised the street by upgrading the Q3 GDP growth to 8.4%, while also upping the GDP estimates for Q1 and Q2 up to 8%. That leaves the Indian economy with the strong possibility of reporting 8% growth for the full fiscal year FY24.

However, that was just one of the macros that favoured the India growth story. The retail inflation, despite the intermittent volatility, tapered to 5.09%. This fall was substantially driven by lower core inflation and to a lesser extent by steady fuel inflation. However, the  concern was food inflation, which continue to stay elevated. The third big data point was current account deficit (CAD), which came in at $10.5 Billion or 1.2% of GDP for Q3FY24. For the full year, the CAD is projected to inch up to $35 Billion or less than 1% of full year GDP. Above all, the fiscal deficit has been managed, albeit by compromising to some extent on government spending. This has made 5.8% for FY24 and 5.1% for FY25 look eminently possible for fiscal deficit as a percentage of GDP. The April 2024 monetary policy was presented in this macroeconomic backdrop.

IS THE RBI SOUNDING INCREASINGLY LIKE THE US FED?

If one were to go through the fine print of the speech delivered by Shaktikanta Das post the policy statement, there were 3 things that came out very clearly. Firstly, Das was emphatic that while inflation was the elephant in the room about 2 years back, it was no longer the elephant in the room. That means; while inflation continues to remain a challenge, it is far from being something that the RBI needs to lose sleep over. The combination of high interest rates and the normalization of supply chain constraints had brought inflation to more rational levels. That was unlikely to change structurally.

Secondly, growth was robust and the gist of the RBI governor statement was that India had not only shown innovation in growth but also resilience in growth. India was not just the fastest growing large economy, but had sustained 7% growth for 3 fiscal years between FY22 and FY24 and could repeat that in FY25 also. Thirdly, the RBI governor hinted that when the going was good, the RBI was not under any pressure to cut rates. Does that sound similar to the “what is the hurry to cut rates” theory propounded by Chris Waller and Michelle Bowman of the Fed? It perhaps does and, like the Fed, the RBI is not going to be in a hurry to rush into rate cuts. It would be calibrated, but more important, the RBI has the macro luxury to wait out key events like elections, monsoons, Kharif and the full budget.

HIGHLIGHTS OF THE RBI POLICY STATEMENT – APRIL 2024

The street was almost in consensus that the RBI would maintain status quo on policy rats in April 2024 policy, which what they did. Here are key takeaways.

• RBI held repo rates at 6.50% for the seventh policy in succession. The last time the repo rates were hiked was in February 2023. However, the repo rates at 6.50% are 135 bps above the pre-COVID repo rate levels of 5.15%. Also, real rates have been above 2% for a long time now. Out of the 6 members in the MPC, 5 members voted to hold repo rates at 6.50%, while Jayanth Varma voted for cutting rates by 25 bps.
• RBI also maintained its monetary stance of “Gradual Withdrawal of Accommodation” in the April 2024 policy. While liquidity shortfall has come down from ₹3.50 Trillion to less than ₹1 Trillion, RBI prefers to keep the money markets at deficit liquidity to ensure inflation expectations are anchored. Here again, Jayanth Varma was the only member to vote for a shift to a Neutral stance.
• Liquidity management will continue to be central to the RBI actions but the urgency reduces compared to February 2024. That is because; the system deficit is down sharply from ₹3.50 Trillion to around ₹0.97 Trillion. The liquidity may actually be in a surplus, if government balances are factored in. Meanwhile, RBI continued to aggressively use Variable Rate Reverse Repos (VRRR) to manage liquidity. Deficit liquidity also ensures smooth transmission of rates.
• What does this mean for linked rates of the RBI. With repo rates held at 6.5%, the pegged rates also maintain status quo. The SDF rate (erstwhile reverse repo) stays pegged at 6.25% (25 basis points below the repo rate). Simultaneously, the Bank rate and marginal standing facility (MSF) stay pegged at 6.75% (25 bps above repo rates).
• The last RBI estimate for FY24 GDP growth was 7% and in the last quarter, the RBI aligns with the NSO (National Statistical Office), which pegs the GDP growth at 7.6% for FY24. However, the street estimates are already pegging the full year FY24 GDP growth at closer to 8% or even marginally above that level. For the FY25 growth estimates, the RBI has maintained its growth estimates at 7.0% for FY25. While it is lower than FY24, the FY25 GDP growth rate will mark the fourth year in arow of 7% GDP growth.
• What about inflation forecast? The last revision in inflation forecast by the RBI was in the August monetary policy, when it raised the inflation forecast from 5.1% to 5.4% for FY24. This was in the aftermath of the spike in food inflation last year after the weak Kharif harvest. That appears to be broadly in line with what India has delivered on the inflation front. However, for FY25, the RBI has maintained its inflation forecast of 4.5%. That means, the RBI expects meaningful downsides in inflation in the coming year. However, the RBI has also cautioned that the Red Sea crisis could be an overhang.
• Finally, what about terminal rates and what about rate cuts? In a sense, the statement by the RBI governor may have disappointed the street. The governor has subtly indicated that considering the lower inflation and robust GDP growth, there may be no reason for the RBI to cut rates for now. That is similar to what the Fed has been indicating in recent weeks. That is understandable. Even as consumer inflation is down to 5.09%, it is still a good 109 bps away from the target of 4%. As central banks the world over are discovering, the last mile in inflation control is incredibly tough. Apparently, the RBI would like to await more data points before arriving at a decision on rate cuts. Over the next 4 months, the RBI would wait for the election outcome, new government formation, data on monsoons, Kharif output and the presentation of the full Budget. Rate cuts look more likely; either towards the end of the second half of FY25 or at the start of Q3FY25.

To an extent, the RBI would try and mirror the US approach to rate cuts so that there is no risk of any monetary divergence. However, any rate cut looks unlikely before the August 2024 policy and the RBI may not yet have crystallized its thinking on terminal rates.

RBI HOLDS ITS INFLATION PEG FOR FY25 AT 4.5%

It was in the August policy that the RBI last hiked the inflation estimate for FY24 from 5.1% to 5.4%. That was in the immediate aftermath of the weak Kharif output reports and erratic monsoons. The delayed sowing during the Kharif season had a deep impact on the inflation reading for July and August and that led to the revision. However, it has since held the FY24 inflation at 5.4%. That appears to be fairly accurate if you consider the cumulative impact of inflation with just one reading left to go for March 2024. As part of its glide path, the RBI has reinforced the FY25 inflation estimate at 4.5%. That would be 50 bps above the long term equilibrium target rate, but well within the RBI upper tolerance limit of 6%.

What is favouring gradual tapering of inflation? Rabi output in the current season has been better than previous year on the basis of acreage. Global supply chain constraints are coming down and that is consistently pulling down the core inflation. Food inflation remains a challenge, but a normal Kharif in 2024 should take care of that. RBI has held its inflation projection for FY25 at 4.5%. In terms of next four quarters; the RBI has projected inflation for Q1FY25 at 4.5%, Q2FY25 at 4.9%, Q3FY25 at 3.8%, and Q4FY25 at 4.6%. The changes are marginal compared to the previous policy statement.

RBI HOLDS GDP GROWTH ESTIMATE AT 7.0% FOR FY25

Let us first talk about the FY24 GDP growth estimates. The last updated given by the RBI for FY24 was 7.0%. However, in the Q3 GDP announcement on the last day of February, the NSO upped its India GDP forecast for FY24 to 7.6%. Normally, the RBI aligns with the NSO in the last quarter of the year. However, the actual GDP growth rate for FY24 is pegged at closer to 8% or even higher, especially after Q3 GDP growth came in at a robust 8.4%. For now, the RBI has held FY25 GDP growth estimates at 7.0%. However, high frequency indicators like core sector growth, IIP growth, PMI numbers and GST collections have been hinting at another robust year for GDP growth in FY25. More importantly, capacity utilization of Indian companies is the highest in recent quarters.

After the latest GDP number for Q3, there have been a spate of upgrades with most estimates pegging FY24 GDP closer to 8.0% and FY25 GDP closer to 7.0%. GDP growth is likely to be helped by strong capex by the government, pick-up in private sector capex and robust consumer demand. The RBI has pegged GDP growth for FY25 at 7.0% and that has been held at the same level. On a quarter-wise basis, the GDP growth is projected at: Q1FY25 at 7.0%, Q2FY25 at 7.1%, Q3FY25 at 6.9%, and Q4FY25 at 7.0%. The FY25 GDP projection of 7.0% is subject to upward revision depending on data flows, but that could still be some time away.

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 key announcements.

• While FPIs are allowed to invest in sovereign green bonds, the RBI now also plans to facilitate non-residents to invest in these bonds. It will, therefore, permit eligible foreign investors in the IFSC to also invest in such bonds.
• The current liquidity coverage ratio (LCR) framework of banks is likely to be placed under review. The focus will be to handle the surge of withdrawals triggered by the extensive use of digital modes of transfers. LCR will be reviewed and revamped on these lines.
• Till date, small finance banks (SFBs) were only permitted to take positions in interest rate futures (IRF). To give them more flexibility in handling forex risk, these SFBs will now also be allowed to deal in permissible rupee interest rate derivative products.
• RBI will enable card-less cash deposits in cash deposit machines (CDMs) with the use of UPI interface. This cash deposit without the need to carry the card, will be achieved through the UPI interface. In addition, UPI access will also be offered for PPIs (prepaid instruments) to facilitate integrated payment management.

The April 2024 monetary policy had little by way of surprise. We await greater clarity when the minutes of the MPC are published on April 19, 2023. The next policy statement on June 05-07, 2024 will be after the new government is in place and with monsoon indications. That should be more interesting.