MPC Continues Hawkish View, Keeps Repo Rate Constant, Projects CPI At 5.4%

The RBI Monetary Policy Committee(MPC), in its meeting held on 4-6 October 2023, has decided to keep repo rates unchanged at 6.5 per cent. Under the Liquidity Adjustment Facility (LAF), MPC has decided to keep the repo rate unchanged at 6.5 per cent, whereas the standing deposit facility(SDF) will be 6.25 per cent and the marginal standing facility along with the base rate is going to be placed at 6.75 per cent.

These decisions are in congruence with the objective of achieving the medium-term target for consumer price index (CPI) inflation or inflation-targeting at 4 per cent within a band of +/- 2 per cent, while supporting growth. 

MPC said in the statement that,” Global growth is losing momentum. 

Inflation is easing gradually but remains well above target in major economies. Concerns about higher for longer rates are imparting volatility to global financial markets. Sovereign bond yields have hardened, the US dollar has appreciated, and equity markets have corrected. 

Emerging market economies (EMEs) are experiencing currency depreciation and volatile capital flows.

MPC has observed that on the supply side, south-west monsoon rainfall recovered during september and ended 6 per cent below the long-period average. The acreage under kharif crops was 0.2 per cent higher than a year ago. Marking a significant boom, the index of industrial production(IIP) rose by 5.7 per cent in July. Also, core industries output expanded by 12.1 per cent in August. Purchasing managers’ indices (PMIs) and other high-frequency indicators of the services sector exhibited healthy expansion in the months of august and September.

On the demand front, MPC highlighted that urban consumption may fluctuate while rural demand is showing signs of revival. With the special focus of the union government on capital expenditure, investment activity is benefitting from public sector capex. 

Strong growth is seen in steel consumption, cement production as well as in imports and production of capital goods, providing a strong backing to the secondary sector. Merchandise exports and non-oil non-gold imports remained in contraction in August, although the pace of decline eased, resulting to a narrowing down of the trade deficit. Services exports improved in August, providing robust support to the invisibles in the balance of payments.

By finding a balance between demand and supply side, MPC held that real gross domestic product (GDP) posted a growth of 7.8 per cent year-on-year (y-o-y) in Q1 FY24 (April-June), underpinned by private consumption and investment demand. 

And, real GDP growth for FY24 is projected at 6.5 per cent, with Q2 at 6.5 per cent, Q3 at 6.0 per cent, and Q4 at 5.7 per cent, with risks evenly balanced.

The MPC also observed that the unprecedented food price shocks are impinging on the evolving trajectory of inflation and that recurring incidents of such overlapping shocks can impart generalisation and persistence. 

Accordingly, the MPC has resolved to remain on high alert, given the prevailing environment of elevated global food and energy prices and global financial market volatility. 

While vegetable prices may undergo further correction and core inflation is easing, the MPC noted that headline inflation is ruling above the tolerance band and its alignment with the target is getting interrupted. Hence, monetary policy needs to remain actively disinflationary.

While keeping confidence on Indian economy, MPC stated, “Domestic economic activity is holding up well and is expected to be boosted by festive consumption demand, pick up in investment intentions and improving consumer and business outlook. 

As the cumulative policy repo rate hike of 250 basis points is still working its way through the economy, the MPC has decided to keep the policy repo rate unchanged at 6.50 per cent in this meeting, but with preparedness to undertake appropriate and timely policy actions, should the situation so warrant.”

The MPC has also assured that it will remain resolute in its commitment to aligning inflation to the target and anchoring inflation expectations. The MPC has also decided to remain focused on withdrawal of accommodation to ensure that inflation progressively aligns to the target, while supporting growth.

“The RBI’s decision to pause along with retaining the withdrawal of accommodation stance was in line with expectations. Importantly, the RBI has explicitly highlighted the need to use Open Market Operations(OMO) sales to modulate liquidity. 

This will weigh down bond markets’ sentiments. Concerns on food inflation were highlighted which can impart upside to headline inflation. We believe that inflation risks remain on the upside given weather related impact as well as commodity prices,” Suvodeep Rakshit, Senior Economist, Kotak Institutional Equities said.

Rakshit also added that global monetary conditions will also weigh on RBI’s policy decisions. The good part is that growth remains resilient and core inflation remains under check. We maintain our call for a prolonged pause on the repo rate at 6.5 per cent well into FY25 while liquidity over the medium term will be aimed at being close to neutral.

“In our opinion, however, the extent of hawkishness in the announcement has reduced with MPC sticking to its annual inflation forecast at 5.4 per cent despite the uncertainty on food prices and the sharp rise in global crude oil prices over the last 2-3 months,” Suman Chowdhury, Chief Economist and Head- Research, Acuité Ratings & Research observed.

While the statement reiterated the need not to be complacent about inflation risks, the reference to the spurt in oil prices and its potential impact has been limited. Further, in the central bank’s assessment, food inflation is unlikely to be a threat in Q3, given the performance of the monsoon. 

“We believe that the likelihood of an extended pause on interest rates remains intact. In our opinion, any possible rate cut may not materialize before the first quarter of FY25. The statement also puts the spotlight on macroeconomic and financial stability with banks and NBFCs having been urged to monitor the sharp growth in personal loans,” Chowdhury emphasised.

“It was already presumed that RBI MPC will maintain status quo on key benchmark rates. No new announcements on liquidity front may offer some solace to short end of the yield curve to remain anchored,” Lakshmi Iyer, CEO-Investment & Strategy, Kotak Alternate Asset Managers Limited highlighted.

She also added that OMO sales may be undertaken if need be, but that is something markets are used to, but with auction and OMO sales not meeting with commensurate demand, bond yields could stay elevated near term.

“What matters is how US treasuries behave going forward – we have seen levels recede from almost 4.90 per cent to the current 4.70 per cent. crude is less rude and has shown some easing lately, yet not fully out of the woods. We expect Indian bonds to trade range bound with cushion at  almost 7.25 per cent to 7.30 per cent levels. With policy decision out of the way, Indian equites will turn attention to earnings season which has just begun. Expect volatilities and consolidation as we move ahead in this quarter,” Iyer pointed out.

As on 22 September 2023, money supply (M3) expanded by 10.8 per cent (y-o-y) and bank credit grew by 15.3 per cent. India’s foreign exchange reserves stood at USD 586.9 billion as on 29 September 2023.