RBI MPC October 2023 Preview: Another status quo likely on rates

4 Oct 2023 , 12:18 PM

The RBI Monetary Policy Committee (MPC) will meet for the October monetary policy discussion between October 04, 2023 and October 06, 2023. The 3-day meeting will culminate in the monetary policy statement issued by the RBI governor on behalf of the MPC. India commenced its hawkish phase of monetary policy in May 2022 and between May 2022 and February 2023 it hiked rates by 250 bps from 4.00% to 6.50%. However, the RBI opted to pause in April 2023 and has continued to pause in June and August too, despite clear signals that inflation was rising. 

For the October monetary policy, the RBI has two inflation recent readings of 7.44% for July and 6.81% for August. However, despite these apparently inflationary signals, the RBI is broadly expected to hold the repo rates at 6.50% even in the October Monetary Policy. Inflation is still a risk factor, but the RBI is betting that the spike in inflation should be more of a cyclical factor than a secular spike in Inflation. After all, core inflation has been consistently coming down even in the last few months.

Global headwinds have worsened since the August policy

In the last few weeks, there have been several headwinds globally, that are likely to have a bearing on the RBI monetary policy decision. Here are some key global headwinds.

1. The Fed has already confirmed that the hawkishness is likely to stay for much longer. While rates may not go up more than 25 basis points from current levels, the more likely scenario is that rates will stay at above 5% till the end of 2024. That is an implication that has spooked the markets in the last few weeks.

    

2. The US government once came close to a shutdown as the necessary bills could not be passed in the House and the Senate on time. In the last minute, the US government managed to eke out a 45 day extension, but that has not gone down well and it even led to the removal of the speaker.

    

3. The US dollar index (DXY) has crossed the 107 mark. Incidentally, it is only the third instance in the last 40 years that the dollar index has gone above 107. The first instance was in 1985, the second instance was in November 2022 and the third instance is October 2023. Stronger dollar is making an import intensive Indian economy quite jittery; as it is effectively translating into imported inflation.

    

4. The US bond yields have surpassed the 4.8% mark and is at the highest level since the year 2001. High bond yields typically build in higher rates staying put for a longer period. The other impact it will have is to spike the bond yields in India and raise the cost of funds domestically. That may have the same corporate impact as the RBI hiking rates.

Apart from these headwinds, additional risks like a slowdown in Europe and delayed recovery in China are already there. This is for the first time since the end of the pandemic that the RBI would be going into the monetary policy announcement with so many negative headwinds.

Will the RBI tinker with rates?

It is very likely that the RBI would just let rates be as it is. At 6.5%, the RBI has done enough tightening and would prefer to believe that the lag effect of the rate hikes should take care of the remaining inflation risk in the economy. Unlike in the US, food inflation remains a big cyclical risk, as we saw this time around. Of course, the food inflation is likely to taper as the Kharif produce starts coming in and the Rabi season commences. However, till then the inflation will continue to remain a challenge. In the last 2 months the inflation was well above the RBI upper tolerance limit of 6%. For September, the consumer inflation number is yet to be announced. However, it is likely to be closer to 5.55%. While that is below the upper tolerance limit of the RBI, it is still a good 155 bps above the RBI target rate of 4% for consumer inflation. However, despite these headwinds, the RBI is likely to hold the repo rates in October 2023 for 3 reasons.

Firstly, the RBI has underlined that the current spike in inflation has been caused by food prices going through the roof. Food prices were first hit by the drought conditions and then by the deluge in some parts. This not only destroyed crops but also impacted the logistics of getting the produce to the Mandis. However, RBI believes that both are being addressed through focused measures and hence will not pose a major problem. In the case of oil, the government will use a mix of subsidies, supply diversification and higher prices to limit the impact on inflation. The second reason the RBI is likely to keep rate static has to do with US monetary policy. It has broadly hinted that upsides to rates may be just about 25 bps from here, but rates would be held high for a longer period. That simplifies things for the RBI as the risk of losing out on negative real rate comparisons is no longer an issue for the RBI now. Lastly, the RBI is likely to avoid rate hikes for purely domestic reasons. The high frequency indicators are flattering in terms of GST collections, PMI and e-way bills. Core sector has grown at 12.1% in August after growing at above 8.3% in June and July. The situation is ripe to nurture growth. RBI would not want to nix this recovery by hiking rates now.

Do we foresee changes to GDP and Inflation estimates

Let us look at the GDP growth and Inflation estimates put out by the RBI in the August 2023 policy statement. In the August RBI policy, it had held its FY24 GDP forecast at 6.5% for the fiscal year. On a quarter-wise basis, the GDP growth was projected at: Q1FY24 at 8.0%, Q2FY24 at 6.5%, Q3FY24 at 6.0% and Q4FY24 at 5.7%. The Q1-FY24 GDP has come in at 7.8%, which his 20 bps lower. But that is likely to be made up in subsequent quarters. However, the RBI is unlikely to tinker with the GDP estimates for FY24, this time around. 

On the inflation front, it may be recollected that the RBI had hiked the inflation target for FY24 by 30 basis points from 5.1% to 5.4%. In terms of next four quarters; the RBI has projected inflation Q2FY24 at 6.2%, Q3FY24 at 5.7%, Q4FY24 at 5.2% and Q1FY25 at 5.2%. Most of the inflation spike to its estimates has been front-ended in the September quarter. In the previous statement, the RBI had already assumed Brent Crude rates of $85-90/bbl. With food inflation coming down and fuel inflation stuck in a range, the RBI may not see the need to revise inflation estimates in the October policy. Hence, despite the spike in inflation in July and August, the RBI is unlikely to further revise its median inflation estimates in the October 2023 policy statement.

What about liquidity management?

In fact, the one thing that markets would be closely tracking would be the language of the RBI and the liquidity management measures. In recent months, several factors have contributed to the surplus liquidity in the system. The first was the withdrawal of the Rs2,000 denomination notes, which added nearly Rs3.55 trillion to the banking system liquidity. In addition, the withdrawal of the incremental CRR (I-CRR) in a phased manner has also contributed to the easing of liquidity in the system. Above all, the RBI has been regularly selling dollars in the spot market to defend the rupee value. That has also led to a surge of rupee liquidity in the market. 

While the RBI would be wary of tightening liquidity too much, it would be also be conscious of the fact that too much liquidity in the system is never a good thing. Hence, the policy statement is likely to see some effort in the direction of keeping liquidity tighter in the coming months. One way would be to adjust the liquidity adjustment facility (LAF), but the RBI is also likely to consider measures like the equivalent of the I-CRR in the October policy to contain the surplus liquidity in the system. 

Forget terminal rate hints; focus on external risks

Markets are expecting the RBI to give hints on the terminal rate of interest or the level at which the RBI will call a stop to rate hikes. That would be too much to expect from the RBI, especially at a time when the global monetary equations are still fluid. The RBI would want to keep its monetary options open and also play its cards close to its chest. Hence, any commitment on the time table for rate action or hints of the terminal levels of interest rates would be too optimistic. RBI is not likely to give any such indications in the policy.

However, a big area that the RBI may consider would be reducing the external vulnerability of the rupee. It is taking policy measures like stopping the export of the rupee trading to offshore markets and selective intervention. However, these are not working to the extent that is needed. In the midst of risking US bond yields, and strength in the dollar index (DXY), the rupee looks particularly vulnerable. The highlight of the policy statement on October 06, 2023 could be a serious game plan to address this issue of external rupee vulnerability. What form and colour it takes, remains to be seen.