RBI keeps repo rates at 6.5% for sixth policy in a row

8 Feb 2024 , 12:54 PM

What happened in the 2 months since December 2023 policy?

The RBI kept repo rates at 6.5% in the February 2024 monetary policy, along expected lines. To understand the background to this status quo decision, it is essential to understand what happened since the last policy in December 2023. Remember, February 2024 marks the sixth consecutive policy when the RBI has held rates at 6.5%. In the last 2 months, the Red Sea crisis worsened with the Houthi rebels attacking cargo ships in the Red Sea route to the Suez Canal. That has raised freight charges and cargo insurance; creating a potentially inflationary situation. US inflation has remained flat to benign.

The big event between the December policy and the February policy was the Interim Budget presented on February 01, 2024. The highlight was the focus on fiscal prudence. The interim budget cut fiscal deficit for FY24 by 10 bps to 5.8% while fiscal deficit target for FY25 was pegged at 5.1%. That is much lower than the street consensus range of 5.3% to 5.5%. The Fed policy in December hinted at rate cuts after a long time, although it is yet to spell out the rate cut timetable. Meanwhile, consumer inflation in India has been under stress due to food inflation. But the real story has been the robust growth story leading the RBI to project FY25 GDP growth at over 7%; marking the 3^rd consecutive year of 7% plus real GDP growth.

Is monetary stance out of sync with liquidity conditions?

That has been one of the concerns over the last few months. In fact, MPC members like Jayanth Varma have openly expressed their view that when liquidity was in deficit, the monetary stance of “gradual withdrawal of accommodation” was inconsistent. That was one of the reasons, Varma persistently voted against continuing the monetary stance. However, the RBI governor has a different explanation of this dichotomy. According to Das, the liquidity conditions turned into deficit only in September 2023, after being in surplus for nearly 54 months in a row, since the start of 2019.

These are based on exogenous triggers like GST, advance tax payouts, demonetization, government spending, back-ending of capex etc. Hence these are temporary and would ease out over time. Also, the RBI was already deploying VRRR and other measures to correct this liquidity deficit. Regarding the stance, the RBI governor feels that the current stance of “gradual withdrawal of accommodation” was essential to move inflation towards the 4% target and to keep inflation expectations anchored. Also, such a stance (even amidst a liquidity deficit) will ensure full transmission of rate hikes between May 2022 and February 2023. This will ensure that last mile inflation issue is addressed.

Highlights of the RBI policy statement – February 2024

The February 2024 policy was expected to maintain status quo on rates and stance; and that is what it did. Here are some key takeaways from the policy statement.

• RBI held repo rates at 6.50% for the sixth policy in succession. The last time the repo rates were hiked was in the February 2023 policy statement. It must be remembered that, at 6.50%, the repo rates are  a full 135 bps above pre-COVID repo rate levels of 5.15%. On the rates front, 5 members voted to hold repo rates at 6.50%, while Jayanth Varma voted for cutting repo rates by 25 basis points.

   

• RBI has maintained its monetary stance of “Gradual Withdrawal of Accommodation” in the February 2024 policy. The RBI would prefer to keep the money markets at deficit liquidity to ensure that inflation moves towards the 4% target and inflation expectations are anchored. Here again 5 members of the MPC voted to maintain the stance of monetary policy, while Jayanth Varma voted to shift to a Neutral stance.

   

• Liquidity management will continue to be central to the RBI actions with the system deficit at around Rs3.50 trillion. However, Das has underlined in his speech that adjusted for government balances, the liquidity may actually be in a surplus. While the RBI has continued to extensively and aggressively use Variable Rate Reverse Repos (VRRR) to manage liquidity, it will prefer to keep a deficit to ensure full transmission of rate hikes.0

   

• Due to the status quo on repo rates at 6.5%, the pegged rates will also maintain status quo. 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 December 2023 monetary policy was presented just after the Q2 GDP data had surprised on the upside. Hence, the RBI had hiked its growth estimate for FY24 by 50 bps from 6.50% to 7.00%. However, the Q3 GDP data is only expected to be announced by MOSPI on the last day of February. Hence, the FY24 estimate of GDP has been maintained at 7.00%. In addition, the GDP growth for FY25 has also been pegged by the RBI at 7.00%, marking the third consecutive year of 7% plus GDP growth. The interim budget has hiked capex by 11.1% this year and the lag effect of 3 years of sustained increase in capex is also likely to reflect in the GDP growth of FY24 and FY25. 

   

• What about inflation forecast? The last revision in inflation was done by the RBI in the August monetary policy, when it raised the inflation forecast from 5.1% to 5.4%. This was in the aftermath of the inflation spike in July after indications of weak Kharif. In the October 2023 and December 2023 policies, the inflation forecast was held at 5.4% and now the February 2024 policy has also held the inflation rate at 5.4%. While food inflation continues to be a challenge for cereals, pulses, and vegetables; the RBI has taken solace from the fact that the Rabi output in 2023 has been better than the previous year. As a result, the RBI has also held inflation for FY25 at 4.5%, clearly indicating at a lower glide path for inflation in the coming year. However, the Red Sea crisis remains the X-factor, although the RBI is confident that the risks can be managed.

   

• Finally, what about terminal rates and what about rate cuts? While the RBI has not spoken explicitly about terminal rates, the indications are explicit enough. The RBI has touched the peak and the likely direction from here looks downwards. However, the RBI is still non-committal on rate cuts due to inflation being above the comfort level. At last count, inflation stood at 5.69% in December 2023, which is still 169 bps away from the durable target of 4%. As Das admitted in his post-policy address; the last mile is normally the toughest journey in disinflation and that is the reality that the RBI is living. Hence, any rate cuts could logically happen only after July or August this year, once the first indications of the Kharif impact are also out in the market.

Going ahead, several factors will form the basis of the RBI rate decision and stance. While domestic inflation and liquidity will certainly be key considerations, the RBI would also focus on the rate cut time table of the Fed, outlook on the Red Sea crisis and how the global supply chains evolve over time.

Inflation pegged at 5.4% for FY24; 4.5% for FY25

The last time the RBI hiked Inflation estimate for FY24 by 30 bps from 5.1% to 5.4% was in August 2023. Even in the February policy, the inflation estimate for FY24 has been maintained at 5.4%. To reiterate the glide path, the RBI has underlined FY25 inflation estimate at 4.5%. Currently, headline inflation in India is veering towards the outer tolerance limit of 6%, but commodity prices continue to be benign. While food inflation has been spiking, fuel prices have been neutral and core inflation has been trending lower. However, erratic monsoons and the evolving Red Sea crisis continue to be major risk factors for inflation outlook in India. The Red Sea crisis could translate into imported inflation for India, even as exports are already taking hit due to time and cost spillovers.

On the positive side, the Rabi output in the current season has been better than previous year on the basis of acreage. For now, the supply side measures of the government have kept food inflation in check, but Kharif 2024 will have to be a lot better. For now, the RBI is awaiting more data confirmation before crystallizing its view on inflation. RBI has held its inflation projection for FY24 at 5.4% and 4.5% for FY25. In terms of next four quarters; the RBI has projected inflation for Q4FY24 at 5.0%, Q1FY25 at 4.5%, Q2FY25 at 5.0%, Q3FY25 at 4.0%, and Q4FY25 at 4.7%. The changes are only marginal compared to the previous policy statement, but these are largely on the back of normal monsoon assumptions.

GDP growth pegged at 7.0% for FY24; and 7.0% for FY25

Back in December, the RBI had just got the MOSPI estimate for Q2FY24 GDP growth at 7.6%. That justified an upgrade and accordingly the GDP growth was upgraded by 50 bps from 6.50% to 7.0%. There have been no GDP data points in between and the Q3FY24 GDP data will only be out on the last day of February 2024. With GDP growing at 7.8% in Q1 and 7.6% in Q2, if Q3 GDP estimate comes around 7.5%, then the RBI may have a strong incentive to hike the GDP growth projection for FY24 and FY25 from the current 7%. There have been several positive triggers. Core sector growth, IIP growth and the high frequency PMI numbers have been robust on a consistent basis. Robust GST collections also point to the economy sustaining GDP at above 7% for Q3 also. While capacity utilization of Indian companies has been positive, the missing link is the revival in rural demand.

Global demand remains a concern, as is evident from the erratic export performance. However, domestic demand is robust and the capex growth of 11.1% for FY25 will keep the capex spending and private sector capex cycle robust. The US GDP first advance estimate for Q4 has come in 120 bps higher than expected at 3.3% while the Atlanta Q12025 GDP peg is also 120 bps higher than expected at 4.2%. IMF has also hiked global growth estimates for 2024, although global trade remains a question mark. The RBI has pegged GDP growth for FY24 at 7.0% and FY25 also at 7.0%. On a quarter-wise basis, the GDP growth is projected at: Q1FY25 at 7.2%, Q2FY25 at 6.8%, Q3FY25 at 7.0%, and Q4FY25 at 6.9%. The FY24 GDP growth projection and FY25 projection of 7.0% are subject to an upward revision depending on the data flowing in for Q3FY24 GDP on the last day of February 2024.

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 2018 regulatory framework for electronic trading platforms will be reviewed. The idea is achieving greater integration of the offshore forex market and the onshore forex market. The revised framework will be put up for public feedback shortly.

   

• RBI will facilitate hedging of gold prices risk through the OTC market on the IFSC. This gives greater flexibility to resident investors as well as businesses dealing in gold. This enables easy and flexible hedging of gold price risk by resident Indians.

   

• RBI moves to ensure greater transparency in MSME loans through a key facts statement (KFS). The KFS will help individual borrowers, digital borrowers and MSMEs to understand the actual cost of the loan, including fees, and administrative charges.

   

• With the rising popularity of Aadhar Enabled Payment Systems (AEPS), the RBI to focus on onboarding process and cyber security. This will include mandatory due diligence for AEPS touchpoints, fraud risk management measures, streamlined onboarding etc.

   

• The RBI has proposed a principle based framework to authenticate digital transactions. This will take the additional factor authentication (AFA) beyond the traditional SMS approach. A detailed paper on this subject is expected shortly.

The February 2024 monetary policy was largely along expected lines in terms of repo rates, inflation projections and GDP growth projections. The policy has been brief; and liquidity is the one area where the RBI will focus on. We will get a more clarity when the minutes of the MPC are published on February 22, 2023. The next policy statement on April 03-05, 2024 will be in the midst of the election fever. June policy could be more significant as there will be a new government in place plus updated data on inflation, growth and Kharif output.