RBI holds repo rates at 6.5%; ups FY 25 GDP growth forecast by 20 bps

7 Jun 2024 , 12:18 PM

WHAT HAS CHANGED SINCE THE APRIL 2024 MONETARY POLICY

For the eighth time in a row, the RBI held repo rates at 6.5% in the June 2024 monetary policy. It may be recollected that the RBI had hiked rates by 250 basis points between May 2022 and February 2023; but has held rates at 6.5% since then. Between the April policy and the June 2024 policy, there have been some major macro developments. For starters, the GDP growth for FY24 came in at a surprisingly robust 8.2%. That is nearly 60 bps better than the NSO’s estimates. Even fourth quarter GDP growth at 7.8% flattered on the upside, against the consensus estimate of 6.5%. However, a much bigger change that happened was on the political front. The election counting was done and the results did surprise the street. Markets were expecting a thumping majority for the NDA government but they ended with just 292 seats. Even that was with the allies, and the BJP itself had just 240 seats, around 32 short of majority. So, it will be an ally-dependent government.

The other big development since the last policy was that the RBI paid out a dividend to the government to the tune of ₹2.11 Trillion. Now that is more than twice the amount estimated by the government in the interim budget. In fact, the government had estimated ₹1.02 Trillion for the RBI dividend plus the dividend from PSU banks. Now the RBI dividend itself is ₹2.11 Trillion. That gives more leeway to the government to further reduce the fiscal deficit as a percentage of GDP and also to boost capex growth in FY25. But, perhaps, the biggest of them all was the fiscal deficit for FY24 coming in at 5.6% of GDP, a good 20 bps lower than the revised estimate in the interim budget. If you combine this with the bumper RBI dividend, we could see fiscal deficit at below 5.0% in FY25, and even below 4.5% in FY26. It is in this background that the June 2024 monetary policy was presented.

DID THE RBI MISS OUT AN OPPORTUNITY FOR PRE-EMPTIVE RATE CUTS?

This is still a highly debatable issue. The RBI had macros totally in favour. The lower than expected fiscal deficit and the higher than expected RBI dividend had already brought down the yields on the 10-year benchmark to below 7%. All that the RBI had to do was to ratify this move with a rate cut of around 25 bps. The other macros are also favouring a rate cut. The GDP growth is robust so lower rates would only be a force multiplier to sustaining the GDP growth. Also, the inflation is now down to the range of 4.8% to 4.9%. That is just about 80-90 bps away from the RBI target, giving enough room for the RBI to cut rates pre-emptively. After all, even the ECB has just cut rates by 25 bps.

There are more compelling reasons for the RBI to consider rate cuts in the current situation of macroeconomic comfort. Firstly, the real rates are well above 200 bps, which is much higher than they need to be. Secondly, the pre-COVID rates were at 5.15% and the current level of 6.50% is a good 135 bps higher. Thirdly, Indian companies are facing higher funding costs pressures as is evident from Q4 results. Perhaps, the political fluidness at the current juncture (the new government is yet to take oath) may have forced the RBI to play it safe and stick to status quo. But it is worth debating whether the RBI could have actually pushed itself to undertake pre-emptive rate cuts in the current MPC meet?

HIGHLIGHTS OF THE RBI POLICY STATEMENT – JUNE 2024

The street was almost in consensus that the RBI would maintain status quo on policy rates in June 2024 policy, considering the pending government formation and the presentation of the final budget. Here are some key takeaways from the MPC statement.

• RBI held repo rates at 6.50% for the eighth policy in succession. The last time the repo rates were hiked was in February 2023. Currently, the repo rates are 135 bps above the pre-COVID repo rates of 5.15%; while the real rates are above 2% for a long time now. Out of the 6 members in the MPC, only 4 members voted to hold repo rates at 6.50%, while Jayanth Varma and Ashima Goyal voted for cutting rates by 25 bps.
• RBI also maintained its monetary stance of “Gradual Withdrawal of Accommodation” in the June 2024 policy. While liquidity shortfall has come down post the elections, RBI prefers to keep the money markets at deficit liquidity to ensure inflation expectations are anchored. Here again, Jayanth Varma and Ashima Goyal voted for a shift to a Neutral stance. After a long time, there were two dissent notes in the MPC policy meet.
• During the current fiscal FY25, the liquidity situation moved from surplus to deficit and again back to surplus in early June 2024. Meanwhile, RBI continued to aggressively use Variable Rate Reverse Repos (VRRR) to mop up surplus liquidity and use variable rate repos (VR₹) to infuse liquidity into the system. One concern for the RBI has been that the just-in-time (JIT) cash management system being followed by the government is making the Indian banks more vulnerable to government liquidity flows.
• What does this rate decision mean for linked rates of the RBI. With repo rates held at 6.5%, the SDF rate (erstwhile reverse repo) stays pegged at 6.25% (25 basis points below the repo rate), while the bank rate and marginal standing facility (MSF) rate stay pegged at 6.75% (25 bps above repo rates).
• Ther is an upgrade to the GDP growth estimate for FY25 by 20 bps from 7.0% to 7.2%. In fact, considering the healthy ICOR (incremental capital output ratio), the street was expecting the GDP growth to be upgraded by 50 bps to 7.5%, but the RBI would obviously want to take that in phases, only after the monsoons estimates and the first estimates of Kharif output. The upgrade is obviously driven by the better than expected FY24 GDP at 8.2%, making India the fastest growing large for third year in a row.
• What about inflation forecast? The forecast for FY25 stand at 4.5%. That already means, the RBI expects meaningful downsides in inflation in FY25, since the average inflation at present is just under 5% in FY25. The RBI did not see any specific reason to reduce the inflation forecast at this juncture from the 4.5% levels. After all, there are several X-factors at this point like the monsoon effect, food prices, possible rebound in core inflation, Red Sea crisis etc. It is likely that once the food inflation picture is clear after the monsoons, the RBI may look to further cut the inflation forecast; and even sync rate cuts with the reduction in inflation estimates.
• The RBI once again remained ambivalent about the timing of rates and the extent of rate cuts. Consumer inflation is now under 5% in FY25 and the growth is robust and can handle the boost from a rate cut. One would have logically expected the RBI to take up pre-emptive rate cuts at a time when the macros are so comfortable and the forex buffers are also very strong. However, the RBI preferred to err on the side of caution. They want to avoid a situation where inflation is again fuelled and that also boosts the inflation expectations. That is when inflation becomes a lot tougher to handle. For now, the RBI may wait for the new government formation and for signals on the fiscal policy when the full budget is announced in mid-July. Till then, it is likely to be wait and watch for the RBI on rate trajectory.

Globally, there appears to be a shift from restrictive monetary policy to accommodative monetary policy. The ECB has taken the lead by cutting rates by 25 bps and the Fed could follow suit. It remains to be seen how the RBI plans to go about handling rates.

RBI HOLDS ITS INFLATION PEG FOR FY25 AT 4.5%

While the IMD has predicted normal rains in this year, it is still unclear whether the onset of rains will be timely and the spread will be adequate. Food inflation is the big X-factor that is stopping the RBI from changing its inflation forecast, since the oil risks have substantially come down with the Brent Crude prices now decisively below the $80/bbl mark. As per the last RBI survey, the pressure of input costs is also going up an that is likely to impact CPI inflation through WPI inflation. The early indications are already there with WPI inflation having decisively turned from negative to positive. While the oil prices are under control now, RBI is apprehensive that the Red Sea crisis could still disrupt the flow of key commodity inputs and spike costs, even in non-oil commodities.

However, the Indian inflation basket has been tapering and the shift in the mix away from food would also help bring down inflation further. That is only likely to happen from FY26 onwards. Considering the diverse pressures, the 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 4.9%, Q2FY25 at 3.8%, Q3FY25 at 4.6%, and Q4FY25 at 4.5%. The changes are marginal in the first and fourth quarter, but quite sharp in the second and third quarters.

RBI RAISES GDP GROWTH ESTIMATE TO 7.2% FOR FY25

With FY24 GDP growth coming in much better than expected at 8.2%, it was time to take a relook at the estimates for FY25 GDP growth. The last update given by the RBI for FY25 was 7.0%. However, after the FY24 GDP growth coming in much higher than expected, there have been obvious upgrades to FY25 growth. In addition, the high frequency indicators like core sector growth, IIP growth, PMI numbers, e-way bills and GST collections have been hinting at another robust year for GDP growth in FY25. GST has been making new records in FY25, already. More importantly, capacity utilization of Indian companies is at the highest level in the last many quarters.

With the FY24 GDP coming in at 8.2% and the incremental capital output ratio (ICOR) robust at 3.4X, an upgrade to the GDP growth was on the cards. Considering the fluid global scenario and the emerging political situation in India, RBI has upgraded the GDP growth for FY25 by 20 bps to 7.2%, compared to 7.0% projected in the April policy. On a quarter-wise basis, the GDP growth is projected at: Q1FY25 at 7.3%, Q2FY25 at 7.2%, Q3FY25 at 7.3%, and Q4FY25 at 7.2%. The FY25 GDP projection of 7.2% is subject to upward revision depending on data flows, but that would most likely happen after the Kharif data.

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.

• The limits for bulk deposits for scheduled commercial banks (SCBs) has been enhanced from ₹2 Crore to ₹3 Crore. The banks are allowed to offer differential raters of deposit as an inceptive on such bulk deposits.
• RBI will rationalize some of the extant guidelines pertain to the export and imports of goods and services in sync with the changing face of cross border transactions. Operational procedures are planned to be simplified and a draft will be put up.
• RBI will set up a digital payments intelligence platform that will share information and intelligence on digital payments, so as to minimize cases of frauds. The platform will harness advanced technologies to mitigate payment related frauds and risks.

The April 2024 monetary policy had little by way of surprise, although it may have missed an opportunity to take up pre-emptive rate cuts. We await greater clarity when the minutes of the MPC are published on June 21, 2024. The next policy statement on August 06-08, 2024 will be after the new government has taken charge, full budget is presented and the first indications of monsoons and Kharif performance is already there.