RBI Policy Meeting Highlights: RBI Governor Shaktikanta Das delivers ‘hawkish pause’; remains cautious on inflation

Here are key takeaways from RBI Policy:

Interest Rates:

- Repo rate unchanged at 6.5%

- Standing deposit facility (SDF) rate remains at 6.25%

- Marginal standing facility (MSF) rate and Bank Rate maintained at 6.75%

- CRR at 4.5%

GDP Projections:

Real GDP growth projection for FY224 retained at 6.5%

- GDP forecast for Q1FY24 at 8% 

- GDP forecast for Q2FY24 at 6.5%

- GDP forecast for Q3FY24 at 6%

- GDP forecast for Q4FY24 at 5.7%

- GDP growth for Q1FY25 is projected at 6.6%

Inflation Forecast

- CPI inflation forecast for FY24 raised to 5.4% from 5.1%

- CPI inflation forecast for Q2FY24 raised to 6.2% from 5.2%

- CPI inflation forecast for Q3FY24 raised to 5.7% from 5.4% 

- CPI inflation forecast for Q4FY24 retained at 5.2%

- CPI inflation forecast for April-June 2024 pegged at 5.2%

Liquidity Measures

All scheduled banks to maintain an incremental cash reserve ratio (I-CRR) of 10% on the increase in their net demand and time liabilities (NDTL) between May 19, 2023, and July 28, 2023.

Revision in IDF framework

The regulatory framework for Infrastructure Debt Funds (IDFs) has been revised.

The key changes in the revised framework are: (i) withdrawal of the requirement to have a sponsor for the IDFs, (ii) allowing IDFs to finance toll-operate-transfer (ToT) projects as direct lenders, (iii) permitting IDFs to raise funds through ECBs, and (iv) making tri-partite agreements optional for PPP projects.

On floating-interest loans

Proposal to put in place a transparent framework for reset of interest rates on floating-interest loans.

UPI

- To launch Conversational Payments on UPI

- Transaction limit of UPI Lite raised to ₹500 from ₹200

- To introduce offline payments using Near Field Communication (NFC) technology

The RBI’s decision to keep the repo rate unchanged at 6.50% is in line with the inflationary trends that have been visible so far as well as those expected going forward. While global growth is expected to be muted this financial year it is encouraging that overall economic activity in the Indian context has been encouraging. 

The RBIs commitment to firmly focus on aligning inflation to the target of 4% signals a benign interest rate scenario going forward. The decision to increase incremental CRR is only intended to absorb the surplus liquidity generated by various factors and is a temporary measure for managing the liquidity overhang and is not likely to impact liquidity in the system. Overall, by keeping interest rates intact for the third straight time, the RBI has signalled that the economy benefits and continues to grow.

The MPC’s decision is seen as a ‘hawkish pause’. The RBI tinkers with liquidity to align it with the current monetary policy stance to enhance transmission of prior hikes. 

Upward revision in inflation forecasts while watching any persistence of idiosyncratic price spikes, strengthens the case of ‘higher for longer’, a theme that is playing out globally too. 

As India CPI inflation starts tapering-off in 2H FY24, we expect the repo rate to remain unchanged at 6.50%. Any price shocks could alter expectations.

Domestic equity market benchmarks, the Sensex and the Nifty extended their losses while rate-sensitive sectors such as banking, automotive, and realty initially turned green briefly, but later fell after the Monetary Policy Committee (MPC) of the Reserve Bank of India (RBI) maintained a status quo on policy rates and stance on Thursday, August 10, as expected. Read here

The RBI kept its policy rate unchanged as expected at 6.5% but its message was clearly hawkish. This was reflected in the upward revision in Q2 FY24 inflation forecast by 100bps to 6.2% and the decision to tighten liquidity through the incremental CRR for banks. The latter could reduce system liquidity balance by ₹60,000-70,000 crore. While the ICRR decision is to be reviewed in September and could be a temporary decision but if inflation pressures linger on, the possibility of continued durable liquidity tightening is likely.

The RBI reiterated its resolve to bring inflation back to 4% on a sustainable basis and highlighted risks beyond the transitory vegetable price pressures. We expect inflation to average at 5.6% in FY24 with inflation expected to print above 6% till September.

Madhavi Arora, Lead Economist, Emkay Global Financial Services explains the impact of incremental CRR:

> Imposition of Incremental CRR (ICRR) of 10% on NDTL (for period of May 19 to July 28 ) would imply a temporary liquidity depletion of ~ ₹1.15 tn/ ₹996 billion (ex of HDFC twin merger). This assumes an effective CRR of 14.5% for the period concerned (4.5%+10%).

 > However, if we assume the ICRR of 10% to include the existing CRR of 4.5%, the liquidity depletion would amount to ₹650 billion/ ₹548 billion ex of HDFC twin merger. We await clarity on RBI’s assessment of ICRR in the press conference. But we believe it has to be the former (i.e 14.5% effective CRR)

 > Overall, this would also lead to some interest loss for banks, as banks were parking the short term liquidity into STPL (short term personal loans) and money markets, instead of parking with RBI in VRRR, which also helped in some softening of CP/CD rates.

 > The immediate impact of RBI absorbing liquidity via ICRR will be mild hardening of money market rates for borrowers including NBFCs/corporates, while for banks as well there will be slight impact on their NIMs (3-4 bps) depending on the instruments where they were parking the money (assuming 14.5% effective CRR). 

 > That said, some banks (PSBs specifically) benefitted more than others from the liquidity glut due to Rs2K notes withdrawal, while others toiled to get deposits by increasing rates.

 > However, all the banks will have to maintain ICRR and thus could be construed as unfair to some banks who did not benefit much from the ₹2,000 notes withdrawal (mainly PVBs).

 > As expected, RBI fired warning shots for Banks/NBFCs given the agressive lending (unsecured loans) and they need to retain adequate provision buffers. As per our banking team, this will force regulated entities to maintain higher PCR or atleast discourage them from reversing provisions (thus some impact on RoA).

> Notably, ICICI, HDFC Bank, Axis Bank amongst banks have maintained a strong contingent buffer amongst banks (0.7-1.2%) and thus should not have any impact.

While vigil is warranted on the trajectory of the monsoon and impact of El Niño, we expect the policy rate to remain unchanged in CY23, with the next policy move likely to be a rate cut in April 2024 as headline inflation moderates. Mortgage interest rates have hardened in recent months, but are likely to remain unchanged for the rest of CY23 as the policy rate stays stable.

The inflation forecast has been increased, with the possibility of further upside risk in the near term. The overall setback is that high inflation is expected to persist for a long period of time, indicating that interest rates will remain high for a long time. Generally, high interest rates affect corporate earnings growth and valuation. However, the impact in India is likely to be nullified due to stable domestic demand and incremental global orders led by Chinas plus one strategy.

There were no surprises in the policy and unlike market expectations, there was no hawkish bend to the commentary. However, as any good central bank would do, the RBI signals that it would continue to look ahead and factor in its anticipated inflation trajectory into future monetary policy decisions. Effectively, the RBI will be looking through the likely spikes in the near term retail inflation as a result of the sharp increases in vegetable prices. The expectation is for such seasonal variations to dissipate with the arrival of the new crop – indicative in the inflation forecast of the RBI. 

While the RBI has sharply increased the Q2 inflation forecast, the Q4 inflation forecast has remained unchanged. The vigil on inflation would continue to factor in all the moving pieces and the RBI keeps itself open to deploying all instruments that could be necessary to align inflation to the 4% target. Even as the rates remain unchanged, the RBI opined that excessive liquidity can pose risks to price stability.

The Incremental CRR was the best option at the current juncture, but it was not the only tool available to us to deal with the liquidity overhang, said RBI Governor Shaktikanta Das.

Private investment is happening in some key sectors like iron and steel, automobiles, petroleum, chemicals and metals, etc. It should happen in other sectors too going forward because the ground conditions are favourable, says RBI Governor Shaktikanta Das.

Liquidity is a dynamic figure and we can't specify if there is a comfortable level. We do fine-tuning operations on both sides, repo and reverse repo. We monitor the situation constantly, said RBI Governor Shaktikanta Das.

The review of incremental CRR for banks will take place on September 8 and depend on conditions prevailing at the time. The review can happen even before September 8, said RBI Governor Shaktikanta Das

Incremental CRR is applicable to all Scheduled banks and internal calculation suggests net impact of incremental CRR will be a little over ₹1 lakh crore, says RBI Governor Shaktikanta Das.

The incremental CRR is a purely temporary measure and considered necessary in the background of the liquidity overhang, said RBI Governor Shaktikanta Das.

We considered it desirable in the interest of financial and price stability. It will have an impact on inflation also, Das added.

There is adequate liquidity in the banking system. We are sensitive to the cash requirement ahead of the festive season, says RBI Governor Shaktikanta Das.

MPC maintains a 3rd consecutive pause on policy rates with continued comfort on external resilience and core inflation. Recent uptick in food inflation is expected to be short lived and is looked through as of now with monsoon picking up well. Stance still maintained as “withdrawal of accommodation” to keep flexibility against any negative surprises on domestic inflation.

Incremental CRR requirement a tad negative, though for a short time only. Overall, a well-balanced policy on expected lines with remote likelihood of any more rate hikes for now. A long wait for rate cut cycle as MPC re-iterates its commitment on 4% inflation target. 

RBI prefers to be in “wait and watch” mode to check if the recent food price inflation is getting generalized and prefers to keep rates on hold and keep the monetary policy unchanged. FY24 inflation has been revised upward from 5.10% to 5.4%. Proactive government measures to curb food inflation should assist in keeping inflation lower. 

RBI is likely to stay on hold for the rest of CY 2023. In order to address the Surplus Liquidity situation, RBI has asked banks to maintain incremental CRR of 10% on Deposit growth between 19th May and 28th July 2023, which will reduce liquidity in the system by ~ ₹90,000 crore.

It's cautiously optimistic monetary policy signalling a resolute focus on inflation targeting. Imposition of an incremental CRR of 10% on incremental liquidity generated out of the withdrawal of ₹2,000 notes, reflects the RBI's deft management of liquidity.

We have seen a dream run over the last 5 months post RBI holding rate hikes. We are seeing a continuity of the stance of withdrawal of accommodation, focus on growth and being vigilant of global macro developments.

However, recent developments around markets factoring in the positives on RBI holding rate hikes, developments around enhanced macro uncertainties, rise in food inflation and crude price and uncertainties around growth across developed and emerging nations can create short-term volatility in the markets.

India is comparatively isolated from the rest of the world in terms of economic factors and the long-term prospects look promising while such headwinds can impact the markets over the short term. Stagger your allocation for the next 2-3 months and don’t go aggressive on the markets at the moment, said Divam Sharma, Founder & Fund Manager at Green Portfolio PMS.