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Nifty jumped on surprised RBI pause but stumbled as it’s not a pivot

RBI gave priority to financial stability over price stability, depending on actual Fed rate action, RBI may or may not hike in June and is very close to a pivot

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On Friday, the focus of Dalal Street was on the RBI policy meeting (MPC) outcome. The market was generally expecting another +25 bps rate hike along with an indication of pause (either after April or June) in line with the Fed. But RBI surprised the market by pausing the repo rate at +6.50%, mainly on the concern of the global (U.S.-Europe) banking crisis, the concern of financial stability, and its spillover effect in India. Subsequently, India’s benchmark stock index Nifty jumped almost +150 points (from around 17540 to 17705 for Nifty Future).

But Nifty also stumbled from the session high soon after RBI presser/Q&A, as Governor Das clarified that the policy action must be seen as a temporary pause, not a pivot. RBI chooses to hold the repo rate at +6.50% after raising +250 bps in the last year (from May 22) to assess the impact of a cumulative hike for FY23 on the real economy. RBI repo rate is now at Jan’19 levels after 6^th consecutive hike in the last 12 months. Nifty Future is now hovering around 17650.

RBI sees an easing of supply chain disruptions from Jan’23, which may help in containing goods inflation in the coming days. RBI also mentioned the banking crisis in U.S. and Europe amid higher interest rate/bond yields which may cause financial instability and another 2008-like GFC to some extent. Thus RBI will again review the overall situation in June and decide on resuming rate hikes or extending further pause.

In other words, RBI will be data-dependent in a meeting-by-meeting approach going forward. RBI clearly said that the fight against elevated, sticky inflation (core) is not over and there is work to be done. RBI is cognizant of higher core inflation and will go for further calibrated policy action (either a +25 bps rate hike or an outright pause) to ensure both price and financial stability as well as economic growth in a sustainable way. RBI also raised the real GDP growth forecast for FY24 to +6.5% from +6.4% and lowered its inflation (CPI) forecast to +5.2% from +5.3%.

 

Full text of RBI statement:

Monetary Policy Statement, 2023-24 Resolution of the Monetary Policy Committee (MPC) April 3, 5, and 6, 2023

On the basis of an assessment of the current and evolving macroeconomic situation, the Monetary Policy Committee (MPC) at its meeting today (April 6, 2023) decided to:

Keep the policy repo rate under the liquidity adjustment facility (LAF) unchanged at 6.50 percent. The standing deposit facility (SDF) rate remains unchanged at 6.25 percent and the marginal standing facility (MSF) rate and the Bank Rate at 6.75 percent.

The MPC also decided to remain focused on the withdrawal of accommodation to ensure that inflation progressively aligns with the target, while supporting growth. These decisions are in consonance with the objective of achieving the medium-term target for consumer price index (CPI) inflation of 4 percent within a band of +/- 2 percent, while supporting growth.

The main considerations underlying the decision are set out in the statement below.

Assessment

Global Economy

Global economic activity remains resilient amidst the persistence of inflation at elevated levels, turmoil in the banking system in some advanced economies (AEs), tight financial conditions, and lingering geopolitical hostilities. Recent financial stability concerns have triggered risk aversion, flights to safety, and heightened financial market volatility. Sovereign bond yields fell steeply in March on haven demand, reversing the sharp increase in February over aggressive monetary stances and communication. Equity markets have declined since the last MPC meeting and the US dollar has pared its gains. Weakening external demand, spillovers from the banking crisis in some AEs, volatile capital flows, and debt distress in certain vulnerable economies weigh on growth prospects.

Domestic Economy

The second advance estimate (SAE) released by the National Statistical Office (NSO) on February 28, 2023, placed India’s real gross domestic product (GDP) growth at 7.0 percent in 2022-23. Private consumption and public investment were the major drivers of growth.

Economic activity remained resilient in Q4. Rabi foodgrain production is expected to increase by 6.2 per cent in 2022-23. The index of industrial production (IIP) expanded by 5.2 percent in January while the output of eight core industries rose even faster by 8.9 percent in January and 6.0 percent in February, indicative of the strength of industrial activity. In the services sector, domestic air passenger traffic, port freight traffic, e-way bills, and toll collections posted healthy growth in Q4, while railway freight traffic registered modest growth. Purchasing managers’ indices (PMIs) pointed towards sustained expansion in both manufacturing and services in March.

Amongst urban demand indicators, passenger vehicle sales recorded strong growth in February while consumer durables contracted in January. Among rural demand indicators, tractor and two-wheeler sales were robust in February. As regards investment activity, growth in steel consumption and cement output accelerated in February. Merchandise exports and non-oil non-gold imports contracted in February while the strong growth in services exports continued.

CPI headline inflation rose from 5.7 percent in December 2022 to 6.4 percent in February 2023 on the back of higher inflation in cereals, milk, and fruits and slower deflation in vegetable prices. Fuel inflation remained elevated, though some softening was witnessed in February due to a fall in kerosene (PDS) prices and favorable base effects. Core inflation (i.e., CPI excluding food and fuel) remained elevated and was above 6 percent in January-February. The moderation observed in inflation in clothing and footwear, and transportation and communication were largely offset by a pick-up in inflation in personal care and effects and housing.

The average daily absorption under the LAF moderated to ₹1.4 lakh crore during February-March from an average of ₹1.6 lakh crore in December-January. During 2022-23, money supply (M3) expanded by 9.0 percent and non-food bank credit rose by 15.4 percent. India’s foreign exchange reserves were placed at US$ 578.4 billion as on March 31, 2023.

Outlook

The inflation trajectory for 2023-24 would be shaped by both domestic and global factors. The expectation of a record Rabi foodgrains production bodes well for the food prices outlook. The impact of recent unseasonal rains and hailstorms, however, needs to be watched. Milk prices could remain firm due to high input costs and seasonal factors. The crude oil prices outlook is subject to high uncertainty. Global financial market volatility has surged, with potential upsides for imported inflation risks.

Easing cost conditions are leading to some moderation in the pace of output price increases in manufacturing and services, as indicated by the Reserve Bank’s enterprise surveys. The lagged pass-through of input costs could, however, keep core inflation elevated.

Taking into account these factors and assuming an annual average crude oil price (Indian basket) of US$ 85 per barrel and a normal monsoon, CPI inflation is projected at 5.2 percent for 2023-24, with Q1 at 5.1 percent, Q2 at 5.4 percent, Q3 at 5.4 percent and Q4 at 5.2 percent, and risks evenly balanced.

A good Rabi crop should strengthen rural demand, while the sustained buoyancy in contact-intensive services should support urban demand. The government’s thrust on capital expenditure, above-trend capacity utilization in manufacturing, double-digit credit growth and the moderation in commodity prices are expected to bolster manufacturing and investment activity. According to the RBI’s surveys, businesses and consumers are optimistic about the future outlook. The external demand drag could accentuate, given slowing global trade and output. Protracted geopolitical tensions, tight global financial conditions, and global financial market volatility pose risks to the outlook.

Taking all these factors into consideration, real GDP growth for 2023-24 is projected at 6.5 percent with Q1:2023-24 at 7.8 percent; Q2 at 6.2 percent; Q3 at 6.1 percent; and Q4 at 5.9 percent, with risks evenly balanced (Chart 2).

With CPI headline inflation ruling persistently above the tolerance band, the MPC decided to remain resolutely focused on aligning inflation with the target. It is essential to rein in the generalization of price pressures and anchor inflation expectations. An environment of low and stable prices is necessary for the resilience in domestic economic activity to be sustained. While the policy rate has been increased by a cumulative 250 basis points since May 2022, which is still working through the system, there can be no room for letting down the guard on price stability.

Taking these factors into account, the MPC decided to keep the policy repo rate unchanged at 6.50 percent in this meeting, with readiness to act, should the situation so warrant. The MPC will continue to keep a strong vigil on the evolving inflation and growth outlook and will not hesitate to take further action as may be required in its future meetings. The MPC also decided to remain focused on the withdrawal of accommodation to ensure that inflation progressively aligns with the target, while supporting growth.

All members of the MPC – Dr. Shashanka Bhide, Dr. Ashima Goyal, Prof. Jayanth R. Varma, Dr. Rajiv Ranjan, Dr. Michael Debabrata Patra, and Shri Shaktikanta Das – unanimously voted to keep the policy repo rate unchanged at 6.50 percent.

Dr. Shashanka Bhide, Dr. Ashima Goyal, Dr. Rajiv Ranjan, Dr. Michael Debabrata Patra, and Shri Shaktikanta Das voted to remain focused on the withdrawal of accommodation to ensure that inflation progressively aligns with the target while supporting growth. Prof. Jayanth R. Varma expressed reservations about this part of the resolution.

The minutes of the MPC’s meeting will be published on April 20, 2023.

The next meeting of the MPC is scheduled during June 6-8, 2023.

Full text of RBI Governor Das’s prepared statement: 6^th April’2023

The year 2023 began on a promising note as supply conditions were improving, economic activity remained resilient, financial markets exuded greater optimism and central banks were steering their economies toward a soft landing.

In just a few weeks during March, this narrative has undergone a dramatic shift. The global economy is now witnessing a renewed phase of turbulence with fresh headwinds from the banking sector turmoil in some advanced economies. Bank failures and contagion risk have brought financial stability issues to the forefront. Given the stubbornness in inflation, central banks continue to tighten monetary policy, although at a reduced pace. Inflation globally has moderated in recent months, but its descent to the target is proving to be long and arduous.

The former chairman of the US Federal Reserve Alan Greenspan once said: “Uncertainty is the defining characteristic of the monetary policy landscape.” He was talking in an era of great moderation and in more normal times compared to today’s situation. What we are witnessing today is unprecedented uncertainty in geopolitics, economic activity, price pressures, and financial markets never seen before. One can imagine the magnitude of challenges central banks and other policymakers face in today’s world.

Decisions and Deliberations of the Monetary Policy Committee (MPC)

The Monetary Policy Committee (MPC) met on the 3rd, 5th, and 6th of April 2023 and assessed the macroeconomic situation and its outlook. It decided unanimously to keep the policy repo rate unchanged at 6.50 percent in this meeting with readiness to act, should the situation so warrant. Consequently, the standing deposit facility (SDF) rate will remain unchanged at 6.25 percent, and the marginal standing facility (MSF) rate and the Bank Rate at 6.75 percent.

The MPC also decided by a majority of 5 out of 6 members to remain focused on the withdrawal of accommodation to ensure that inflation progressively aligns with the target, while supporting growth. Let me emphasize that the decision to pause the repo rate is for this meeting only.

I would now like to explain the MPC’s rationale for these decisions on the policy rate and the stance. While the recent high-frequency indicators suggest some improvement in global economic activity, the outlook is now tempered by additional downside risks from financial stability concerns. Headline inflation is moderating but remains well above the targets of central banks. These developments have led to heightened volatility in global financial markets as reflected in sizeable two-way movements in bond yields, a fall in equity markets, and the US dollar shedding its gains from its peak of September 2022.

Amidst this volatility, the banking and non-banking financial service sectors in India remain healthy and financial markets have evolved in an orderly manner. Economic activity remains resilient and real GDP growth is expected to have been 7.0 percent in 2022-23. Consumer price inflation, however, has increased since December 2022, driven by price pressures in cereals, milk, and fruits. Core inflation remains elevated.

Looking ahead, headline inflation is projected to moderate in 2023-24. The monetary policy actions taken since May 2022 are still working through the system. Accordingly, the MPC decided to keep the policy rate unchanged to assess the progress made so far, while closely monitoring the evolving inflation outlook. The MPC will not hesitate to take further action as may be required in its future meetings.

To recapitulate the actions taken so far, we have increased the policy repo rate cumulatively by 250 bps in the last 11 months starting May 2022. This was preceded by the introduction of the Standing Deposit Facility (SDF) at a rate 40 bps higher than the fixed rate reverse repo. Thus, the effective rate hikes since April last year have been 290 bps.

These increases have been fully transmitted to the overnight weighted average call money rate (WACR), the operating target of monetary policy, which has gone up from a daily average of 3.32 percent in March 2022 to 6.52 percent in March 2023. It is now necessary to evaluate the cumulative impact of these rate hikes. Under these circumstances, we have to be extremely prudent in our actions. We have always been very watchful and have adopted a calibrated and balanced approach and will continue to do so.

When we started the rate cut cycle in February 2019 to provide support to growth, the CPI inflation was around 2 percent and the policy repo rate was 6.50 percent. Now, the policy rate is 6.50 percent but inflation is 6.4 percent (February 2023). Overall, inflation is above the target and given its current level, the present policy rate can still be regarded as accommodative. Hence, the MPC decided to remain focused on the withdrawal of accommodation.

Assessment of Growth and Inflation

Growth

As stated earlier, India’s real gross domestic product (GDP) is expected to have recorded a growth of 7.0 percent in 2022-23. Hence, economic activity remains resilient.

On the supply side, Rabi foodgrain production is estimated to increase by 6.2 percent in 2022-23. PMI manufacturing remained robust at 56.4 in March, recording expansion for the 21st consecutive month due to favorable domestic demand. Services sector activity exhibited buoyancy. PMI services remained in the expansion zone at 57.8 in March, driven by favorable demand conditions and new business gains.

Aggregate demand conditions were resilient in Q4 of 2022-23, even as private consumption showed some signs of a slowdown. Urban demand indicators like passenger vehicle sales and credit card spending registered robust growth in February, while consumer durables contracted in January. Rural demand indicators such as consumer non-durables, tractor, and two-wheeler sales registered healthy growth. Investment activity exhibited buoyancy on the back of the government’s thrust on infrastructure spending, high capacity utilization and revival in corporate investment in certain key sectors.

Non-food bank credit rose by 15.4 percent (y-o-y) as on March 24, 2023. The total flow of resources to the commercial sector has increased by ₹26.0 lakh crore during 2022-23 as against ₹19.0 lakh crore a year ago. Merchandise exports and non-oil non-gold imports contracted in February. Services exports continued to register robust growth. Supply chains are returning to normalcy globally as well as domestically.

Looking ahead, the higher Rabi production has brightened the prospects for the agriculture sector and rural demand. The steady growth in contact-intensive services should be positive for urban demand. The government’s focus on capital expenditure, capacity utilization above the long-period average, and moderating commodity prices should bolster manufacturing and investment activity. The drag from net external demand may continue due to increased global headwinds. The protracted geopolitical tensions and global financial market volatility pose downside risks to the outlook.

Taking all these factors into consideration, real GDP growth for 2023-24 is projected at 6.5 percent, with Q1 at 7.8 percent; Q2 at 6.2 percent; Q3 at 6.1 percent; and Q4 at 5.9 percent. The risks are evenly balanced.

Inflation

The softening in inflation during November-December 2022 turned out to be transitory with CPI headline inflation breaching the upper tolerance threshold during January-February 2023. A sharp turnaround in food inflation drove the pick-up in headline inflation as core inflation remained elevated across a range of goods and services.

Looking ahead, the expectation of a record Rabi harvest bodes well for easing food price pressures. There is already evidence of a correction in wheat prices in March on supply-side interventions by the Government. The impact of the recent unseasonal rains in some parts of the country, however, needs to be watched. Global commodity prices moderated significantly from their heightened levels a year ago.

As our surveys point out, cost conditions have somewhat eased. Inflation expectations of households have also edged down. On the upside, adverse climatic conditions are a risk to the future inflation trajectory. Milk prices are also likely to remain firm going into the summer season due to tight demand-supply balance and fodder cost pressures. The rising uncertainty in international financial markets and imported inflation pressures need to be monitored closely.

Taking into account these factors and assuming an annual average crude oil price (Indian basket) of US$ 85 per barrel and a normal monsoon, CPI inflation is projected to moderate to 5.2 percent for 2023-24; with Q1 at 5.1 percent; Q2 at 5.4 percent; Q3 at 5.4 percent; and Q4 at 5.2 percent. The risks are evenly balanced.

Let me now summarize what I have said so far. We are living in very volatile times. The sudden announcement of an output cut by OPEC+ a few days ago and the resultant jump in crude oil prices is yet another evidence of this volatility. The overall outlook thus remains dynamic and fast evolving. Our monetary policy in the recent period has aimed for a non-disruptive normalization from the pandemic-era stimulus measures.

Even as monetary policy moved decisively to the withdrawal of accommodation, financial conditions evolved in line with the productive requirements of the economy. Growth has since then become broad-based. Inflation has softened from its elevated levels a year ago; however, it remains above the upper tolerance band. Projections for 2023-24 point to a softening in inflation, though the disinflation is likely to be gradual and protracted, given the rigidity in core or underlying inflation pressures.

At this stage, we remain watchful of the evolving outlook and the impact of our actions during the past year on the broader real economy. While we have kept the policy rate unchanged, it is important to bear in mind that this decision was taken based on our assessment of the macroeconomic and financial conditions concerning the information available up to today.

Our job is not yet finished and the war against inflation has to continue until we see a durable decline in inflation closer to the target. We stand ready to act appropriately and on time. We are confident that we are on the right track to bring down inflation to the target rate over the medium term. As we proceed towards this objective, I recall the wise counsel of Kautilya more than two thousand years ago: “Be not slack before the whole job is finished.”

Financial Stability

With the fight against inflation far from over, the global economy is now confronted with serious financial stability challenges from the recent banking sector developments in some advanced economies. This calls for a reappraisal of the responsibilities of the regulators and the regulated entities the world over and their collective role in safeguarding the stability of the financial system. While regulators need to identify potential vulnerabilities and take proactive regulatory and supervisory measures, it is incumbent upon regulated institutions to exercise due diligence in their risk management and corporate governance practices. They need to pay close attention to asset-liability mismatches and the profile of their deposit base while building up adequate capital buffers and conducting periodic stress tests.

It is in this context that we, in the Reserve Bank, have focused on macro-and micro-prudential measures in recent years to prevent the build-up of financial vulnerabilities. We have adopted a prudent approach towards regulation and supervision and have taken several steps in these areas in recent years.

Some of these regulatory measures include the implementation of leverage ratio, liquidity coverage ratio (LCR), net stable funding ratio (NSFR), large exposures framework (LEF), guidelines on governance in commercial banks, scale-based regulatory (SBR) framework for NBFCs, among others. To create a buffer to shield banks from adverse yield movements, the Reserve Bank had advised banks to create an investment fluctuation reserve (IFR) with a desirable floor of IFR at 2 percent of the held-for-trading (HFT) and available for sale (AFS) portfolios. Moreover, the capital and liquidity requirements are uniformly applied to all banks, irrespective of their asset size and exposure.

Our supervisory systems have also been strengthened significantly in recent years. We have adopted a unified and harmonized supervisory approach for commercial banks, NBFCs, and urban cooperative banks (UCBs). The focus is now more on identifying the root cause of vulnerabilities, rather than dealing with the symptoms alone. As a result, the Indian banking system remains sound and healthy, with strong capital and liquidity positions, improving asset quality, better provisioning coverage along with improved profitability.

Note: The Capital to Risk Weighted Asset Ratio (CRAR) for the banking system at 16.0 percent as of end-December 2022 remained well above the required minimum of 9.0 percent. The Liquidity Coverage Ratio (LCR) of SCBs remained at 145 percent in February 2023, while the Net Stable Funding Ratio, the long-term measure for liquidity, of SCBs, is well above the minimum regulatory requirement of 100 percent. The net NPAs of the banking system were 1.2 percent in December 2022.

Nevertheless, we are keeping a close watch on the banking sector turmoil in some developed countries. In this context, let me once again recall Kautilya’s wisdom, which remains relevant even for today’s world: “In the interests of the prosperity of the country, …..[we] should be diligent in foreseeing the possibility of calamities, try to avert them before they arise, overcome those which happen, remove all obstructions to economic activity …..”.

Liquidity and Financial Market Conditions

The Reserve Bank will continue to adopt a nuanced and agile approach to liquidity management. Amidst large moderation in surplus liquidity, the Reserve Bank conducted 14-day variable rate repo (VRR) auctions (main operation) on February 10 and March 10 and a fine-tuning 5-day VRR auction on March 24, 2023. In the period ahead, the Reserve Bank will remain flexible in meeting the productive requirements of the economy through two-way operations, as may be necessary. We will also ensure the completion of the Government borrowing program in a non-disruptive manner while maintaining orderly market conditions during 2023-24.

The Indian Rupee has moved in an orderly manner in the calendar year 2022 and continues to be so in 2023 also. This is reflective of the strength of domestic macroeconomic fundamentals and the resilience of the Indian economy to global spillovers. We remain watchful and focused on maintaining the stability of the Indian rupee.

External Sector

The current account deficit (CAD) for the first three quarters of 2022-23 stood at 2.7 percent of GDP. In Q3, CAD narrowed significantly to 2.2 percent from 3.7 percent in Q2 on account of a lower merchandise trade deficit and robust growth in services exports. Strong software services export growth was witnessed across key verticals such as IT services, Business Process Management (BPM), and engineering research and design (ER&D), supported by a rise in global capability centers (GCCs).

The merchandise trade deficit further narrowed during January and February 2023 from its level in Q3:2022-23 on the back of a sustained decline in imports. Moreover, India’s services exports continued to grow at a healthy pace in the first two months of 2023. Better growth prospects of the gulf cooperation council (GCC) countries are expected to keep remittances robust. In fact, inward gross remittances touched an all-time high of US$ 107.5 billion during the calendar year 2022. The CAD is expected to remain moderate in Q4 2022-23 and in the year 2023-24 at a level that is both viable and eminently manageable.

Overall, our external sector indicators have improved significantly. Foreign exchange reserves have rebounded from US$ 524.5 billion on October 21, 2022, and now stand in excess of US$ 600 billion taking into account our forward assets.

Additional Measures

Developing an Onshore Non-deliverable Derivative Market:

Banks in India with IFSC Banking Units (IBUs) were earlier permitted to transact in Indian Rupee (INR) non-deliverable foreign exchange derivative contracts (NDDCs) with non-residents and with other eligible banks having IBUs. It is now proposed to permit banks with IBUs to offer NDDCs involving INR to resident users in the onshore market. This measure will further deepen the forex market in India and provide enhanced flexibility to residents in meeting their hedging requirements.

Enhancing the Efficiency of Regulatory Processes

At present, the processes for entities to make applications seeking license/authorization or regulatory approvals from the Reserve Bank under various statutes/regulations take place in both online and offline modes. To simplify and streamline such processes and in line with the Union Budget 2023-24 announcement, it has been decided to have a secured web-based centralized portal named ‘PRAVAAH’ (Platform for Regulatory Application, Validation, And Authorizations) for such processes. The portal will show time limits for deciding on the applications/approvals sought. This measure will bring greater efficiencies into regulatory processes and facilitate ease of doing business for the regulated entities of the Reserve Bank.

Development of a Centralized Web Portal for the Public to Search Unclaimed Deposits

At present, the depositors or beneficiaries of unclaimed bank deposits of 10 years or more have to go through the websites of multiple banks to locate such deposits. Now, to improve and widen the access of depositors/beneficiaries to information on such unclaimed deposits, it has been decided to develop a web portal to enable search across multiple banks for possible unclaimed deposits. This will help depositors/beneficiaries in getting back unclaimed deposits.

Grievance Redress Mechanism relating to Credit Information Reporting by Credit Institutions and Credit information provided by Credit Information Companies

Recently, Credit Information Companies (CICs) were brought under the purview of the Reserve Bank Integrated Ombudsman Scheme (RB-IOS). It is now proposed to put in place the following measures: (i) a compensation mechanism for delayed updation/rectification of credit information reports; (ii) a provision for SMS/email alerts to customers whenever their credit information reports are accessed; (iii) a timeframe for inclusion of data received by CICs from Credit Institutions; and (iv) disclosures on customer complaints received by CICs. These measures will further enhance consumer protection.

Operation of Pre-Sanctioned Credit Lines at Banks through the UPI

The Unified Payments Interface (UPI) has transformed retail payments in India. UPI’s robustness has been leveraged to develop new products and features from time to time. Recently, RuPay credit cards were permitted to be linked to UPI. This was in addition to the existing facility of linkage of UPI with deposit accounts. It is now proposed to expand the scope of UPI by permitting the operation of pre-sanctioned credit lines at banks through the UPI. This initiative will further encourage innovation.

Conclusion

Since early 2020, the world is going through a period of extreme uncertainty. In this daunting environment, India’s financial sector remains resilient and stable. Overall, the broadening of economic activity; the expected moderation in inflation; the fiscal consolidation with a focus on capital spending; the significant narrowing of the current account deficit to more sustainable levels; and the comfortable level of foreign exchange reserves are welcome developments which will further bolster India’s macroeconomic stability.

This allows monetary policy to remain unwaveringly focused on inflation. With unyielding core inflation, we remain firm and resolute in our pursuit of price stability which is the best guarantee for sustainable growth. The impact of our actions over the past 12 months is still playing out and would increasingly weigh on the future inflation trajectory. As I noted in my policy statement in April last year, our goals of price stability, sustained growth, and financial stability are mutually reinforcing and we continue to be guided by this approach.

We remain vigilant and ready to face the challenges with a firm commitment to price and financial stability. We are inspired by what Mahatma Gandhi said: “…inexhaustible perseverance and patience… knows no defeat.”

Highlights of RBI MPC Presser and Q&A:

·         Governor Das asked journalists whether there was some element of surprise in holding the rate and happily enjoyed the affirmative response

·         Today’s monetary policy may be characterized in just one word: It’s a pause, not a pivot

·         Considering the effective reverse repo (SDF) hike of +290 bps since last Mar’22, there is a cumulative increase/transmission of around +320 bps in WACR (from around +3.32% to +6.52% till Mar’23); so it’s essential to  assess the cumulative impact of rate hikes so far

·         The MPC remains watchful and does not hesitate to take required action in future meetings; so the job of getting inflation under control toward the target is not yet finished

·         In India, as there is overall financial and macro-economic stability, the RBI's priority continues to be price stability

·         The Indian economy remains resilient. It has withstood successive global shocks over the last 3 years. Each shock came with unprecedented suddenness and spillovers. Major economies are still reeling under their pressure. However, the Indian economy, amidst all this, remains resilient

·         The Indian banking system is sound and healthy so far

·         Average inflation (CPI) for the FY24 may be around +5.2% against the target of +4.0%; thus the RBI will continue to work hard to achieve the target

·         A pause in rate hike is for this meeting only, not guaranteed for future meetings

·         RBI Monterey policy is primarily determined by domestic factors

·         Overall RBI is optimistic about the Indian economy

·         Not prudent to provide specific forward guidance on rates because it may create unnecessary expectations and confusion

·         AT1 -bond ecosystem in India remains stable and robust (despite some issues with Yes Bank and Credit Suisse saga in Switzerland)

·         Relative to the last meeting, RBI is now much better off on real interest rate terms

·         RBI’s growth, and inflation forecast factors in the change in oil price assumption

·         Current MPC stance, economic projections are valid only till the June policy meeting

·         RBI is taking CPI data from NSO at face value, not assuming a change in CPI methodology

·         In India, RBI is fighting inflation in conjunction with supply-side actions by the government as demand-side action only (through interest rate hikes) is not sufficient alone

Conclusions:

RBI paused on 6^th April as the market was pricing also a Fed pause/pivot on 3^rd May amid subdued economic data, regional banking crisis, and the renewed concern of stagflation The RBI may want to maintain the present policy rate differential of 1.50%-2.50% with Fed depending upon the actual core inflation differential. Thus RBI paused, but not pivoted as RBI may want to see actual Fed rate action on 3^rd May and any guidance for the 14^th June FOMC meeting. But after better than expected/Goldilocks U.S. NFP job report for March, published on 7^th April (Good Friday holiday), the market is now again expecting a Fed rate hike of +25 bps on 3^rd May.

Fed was already behind the inflation curve from early 2021 when the economy opens fully after the 2020 COVID disruption. Fed should have started to normalize its ultra-loose monetary policy in early 2021 rather than starting the process (telegraphing about QE ending and potential rate hikes) in late 2021. In the process, Fed created synchronized global inflation/stagflation as almost all major G20 central banks usually follow Fed policy action for currency (USD) and bond yield differential.

Now (till the banking crisis emerged in 2^nd week of Feb’23), seeing inflation out of control, both Fed and ECB were engaged in ultra-hawkish jawboning to tighten monetary/financial conditions, resulting in a rapid increase in bond yields and HTM (bond portfolio) loss of mid-size U.S. regional banks, who are not so much efficient to manage interest rate increase in an efficient/professional way.

Fed is itself now suffering from huge MTM loss (unrealized) as it’s offering trillions of dollars at higher reverse repo rates to banks; Big U.S. banks are major beneficiaries of higher reverse repo rates (risk-free return) from Fed. But small/mid-sized U.S. regional banks like SVB have a significant mismatch between asset and liability, resulting in the current failure.

Fed is now going to pause after one or two more hikes as it believes banks, especially smaller ones will tighten lending norms, which will eventually tighten financial conditions more and consumer demand thereby, helping lower inflation. For the last year, Fed was too occupied with jawboning to control the market and may not have focused adequately on bank supervision/regulation; especially for vulnerable small/mid-size U.S. regional banks. Here is also Fed was far behind the curve, nearly inviting another 2008-type GFC.

As the immediate concern of financial stability eases, Fed may go for their planned rate hikes in a calibrated manner to ensure price and financial stability as well as credibility. Fed may go for calibrated +25 bps rate hike on 3^rd May, and may also be 14^th June for a terminal rate of 5.25-5.50% and then pause. Fed will ensure financial stability with liquidity tools and price stability with interest tools as unlike during 2008-10, core inflation is still substantially higher than the +2% targets.

As per Taylor’s rule, for the US: (Fed’s favorite)

Recommended policy rate (I) = A+B+(C+D)*(E-B) =0.00+2.00+ (0+0)*(5.5-2.00) =0+2+3.5=5.5%

Here for U.S. /Fed

A=desired real interest rate=0.00; B= inflation target =2.00; C= permissible factor from deviation of inflation target=0; D= permissible factor from deviation of output target from potential=0.00; E= average core inflation=5.5% (average of core PCE and CPI)

In a way, now May hike of +25 bps is almost certain for Fed while there is a question mark for June. But there will be no rate cuts at least till mid-2024 contrary to market expectations. After mid-2024, Fed may begin talking about rate cuts (just ahead of the Nov’24 U.S. Presidential election) to boost Wall Street (risk trade) and also to ensure lower bond yields to rescue U.S. regional banks and itself. Fed has to also ensure lower borrowing costs for the U.S. government as well as businesses and households.

India’s RBI may also hike +0.25% on 8^th June if Fed goes for two consecutive hikes on 3^rd May and 14^th June. Unlike RBI, Fed does not attempt to surprise the market and is sharing/providing appropriate forward guidance through not only official Fed communications but also regular Fed talks. Thus by 31^st May (the Fed blackout period begins), the market as well as RBI should know with almost 100% certainty whether Fed will go for another +25 bps rate hike on 14^th June. If Fed refrains from any rate hike on 14^th June and only goes for a +25 bps rate hike on 3^rd May, then RBI may not go for any hike on 8^th June and may continue to be on pause until core inflation does not spike abnormally. Going by the trend between RBI and Fed rate action since Jan’22, RBI may go for a +25 bps rate hike every alternate meeting if Fed goes for similar rate hikes in every meeting (in a hypothetical scenario).

India’s core CPI continues to be sticky around +6.00% since Jan’21 and consistently above +4.0% targets even before COVID. Like Fed, RBI is also far behind the inflation curve for a long. Thus RBI wants to ensure a real positive rate, by around +100 bps (restrictive levels) wrt at least average core inflation. RBI continued to tighten to keep interest rate/bond yield differential and also USDINR under control, which will also control imported inflation and manage overall price stability. RBI has to tighten in a calibrated way to bring inflation down by curtailing demand; i.e. slowing down the economy to some extent without causing an all-out recession for a safe and soft landing.

RBI Governor Das indicated a pause before some weeks of the RBI April meeting:

In a recent speech, RBI Governor Das blamed higher inflation on geopolitical tensions and economic sanctions, which need to be properly resolved for stability in global macros. As a Central Bank, RBI’s job is to hike rates well into the restrictive zone to curtail demand, so that it can match with currently constrained supply, resulting in lower inflation. RBI as-well-as Fed has done their jobs almost fully and may hike once/twice more in May/June and a long pause thereof at least till Dec’23 before any plan to cut (if core inflation indeed goes down towards target zones).

In the last year, RBI hiked the +250 bps repo rate and core CPI declined -100 bps from around +7.0% to +6.0% on average; Indian 10Y bond yield also moved up around +100 bps from around +6.0% to 7.0%. At this run rate, if RBI goes for a pause around the 6.50-6.75% repo rate, the core CPI may further fall to around +5.0% by Mar’24 and +4.0% target by Mar’25.

In India, a higher interest rate may not contain core inflation alone for various reasons, like the government’s indirect control over domestic fuel (petrol & diesel) as per political compulsion. In the last year, global crude oil prices tumbled from around $117 to $67 and India is buying a major portion of Russian oil significantly cheaper than the market price. But the Indian government has not allowed OMCs to reduce retail prices of petrol & diesel apparently to ensure that OMCs remain profitable (after adjusting any previous losses). The government is also collecting huge tax revenue from fossil fuel, which is helping in deficit spending (led by infra spending). The Government may allow OMCs to reduce prices ahead of any major state election and also the early 2024 general election.

In any way, as the government has not passed the benefit of lower crude oil prices into the retail price of petrol & diesel, India’s core inflation remains elevated and sticky around +6.0% for most of 2022 and even early 2023. Also in India, there is significant wage inflation for not only government employees (through DA) but also for private employees, especially corporates; i.e. wage increase is higher than productivity gain. This in turn is also resulting in higher goods and service prices, creating a cycle of higher inflation.

Also, India’s fiscal stimulus; i.e. deficit spending, and grants by the government is creating inflation directly/indirectly (through systematic corruption route). India’s almost 30% population, equivalent to almost the U.S. population may belong to the high middle class/rich category due to good salary income (often more than productivity levels), corruption /unaccounted money, vibrant capital/real estate market, and growing startups and digital ecosystem (You tubers). Most of these categories of the high middle-class population are rich in cash and generally don’t need to borrow heavily for consumption or investment.

Thus despite higher borrowing costs, overall consumer demand in India remains resilient and so core inflation remains elevated and sticky around +6%, which is quite bad for the rest 70% of the population, which belongs to the lower-middle class or under APL/BPL. This 70% of the population also forms a formidable vote bank for any political party and thus any government, which is not able to manage inflation consistently, will be vulnerable in the next election. The same is true for employment.

As per Taylor’s rule, for India:

Recommended policy rate (I) = A+B+(C+D)*(E-B) =0.50+4+ (1.5+0)*(6-4) =0.50+4+1.5*2=0.50+4+3=7.50%

Here for RBI/India:

A=desired real interest rate=0.50; B= inflation target =4; C= permissible factor from deviation of inflation target=1.5 (6/4); D= permissible factor from deviation of output target from potential=0; E= average core CPI=6

If Fed continues to hike even after June’23 to +6.00% by Sep’23 (in case U.S. core inflation surges more), then RBI also has to hike (under still elevated/sticky core inflation). Thus RBI may like to keep the repo rate at 7.00% to 7.50% in CY23, depending upon the Fed rate action; as USD is the reserve/global currency, every major Central Bank has to follow Fed action to maintain bond yield/currency and policy differential (whatever may be the narrative) to control imported inflation. Thus RBI again reminded the market on the 6^th April MPC statement about the real rate of interest of +4.50% in Feb’2019 (when RBI starts the pre-COVID rate cut cycle to support economic growth); in Feb’2019, RBI repo rate was +6.50%, while headline CPI was around +2.00%, but core CPI was around +5.25%. Thus the actual real rate of interest about core CPI was around +2.25% in Feb’2019 against Rajan’ (former RBI Governor) preference of around +1.50% (1.00-2.00%).

Bottom line:

Under Governor Das and Modi admin, RBI may prefer to keep the real rate of interest around 0.50-1.50%; as India’s core CPI is now averaging around +6.00%, RBI may keep the terminal rate between 6.50%-7.50% in the coming days depending upon the actual Fed rate action and domestic core inflation trajectory. As there are a series of state elections in 2023 and also a general election by May’24, RBI may keep the terminal repo rate around 6.50-6.75% if Fed does not go beyond +5.50% and India’s core CPI stays below +6.50%.

Looking ahead, whatever may be the narrative, technically Nifty Future now has to sustain over 17600 for a further rally to 17825/17875*-17925/18150*and further 18400-19030 in the coming days (Bullish side). On the flip side sustaining below 17550, Nifty Future may again fall to 17350/17250-17145/17000 and 16950/16800*-16725/16650* in the coming days.

 

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