Pause in repo rate hike during uncertain times holds a larger picture

This makes it abundantly clear that the pause is only to get the full picture of 250 basis hike in rep rate by RBI from last May. By taking into account the introduction of SDF at a rate 40 bps higher than the fixed rate reverse repo, the effective rate hike since April last year has been 290 bps

Announcing the Monetary Policy Statement 2023-24 on April 6 after a three-day meeting, the Monetary Policy Committee (MPC) said that it has decided to pause the Repo Rate hike as against the market expectation of 25 basis rate hike. MPC decided to keep the policy rep rate under the liquidity adjustment facility (LAF) unchanged at 6.50 per cent. Accordingly, the standing deposit facility (SDF) remains unchanged at 6.35 per cent and the marginal standing faculty (MSF) rate and bank rate at 6.75 per cent.

This was a positive surprise to both equity and bonds.

RBI Governor Shaktikanta Das said later “Let me emphasise that the decision to pause on the repo rate is for this meeting only. The decision was taken on the basis of our assessment of the macroeconomic and financial conditions with reference to 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 are ready to act appropriately and in time.”

This makes it abundantly clear that the pause is only to get the full picture of 250 basis hike in rep rate by RBI from last May. By taking into account the introduction of SDF at a rate 40 bps higher than the fixed rate reverse repo, the effective rate hike since April last year has been 290 bps.

Inflation: From a recent low of 5.7 per cent in December 2022, inflation increased by 80 bps to 6.5 per cent in January and 6.4 per cent in February 2023. RBI has a mandated inflation target of 4 per cent with a maximum limit of six per cent.

It may be recalled that in the February 2023 Monetary Policy, RBI had hiked rep rate by 25 basis points making the repo rate at 6.50 per cent. RBI is keen to bring down core inflation and CPI inflation below the targeted level of four per cent in the medium term wherein the current last reported inflation at 6.4 per cent as at February 2023 is much above the upper band of 6 per cent. RBI expects CPI inflation to moderate at 5.2 per cent for 2023-24 with Q1 at 5.1 per cent, Q2 at 5.4 per cent, Q3 at 5.4 per cent and Q4 at 5.2 per cent. From the February 2023 projection of inflation at 5.3 per cent for 2024, the current projection for 2024 is at 5.2 per cent.

Some of the reasons are that the global commodity prices have moderated significantly from their heightened levels a year ago. Crude oil prices (Indian basket) were assumed at $ 85 per barrel as against the earlier projection of $ 95 per barrel. The recent sudden announcement of an output cut by OPEC+ and the resultant jump in crude oil prices are to be watched.

RBI also expects a record Rabi harvest. The impact of El Nino on the normal rains and resultant climate change are other risks one should watch out for. The RBI Governor stated that the uncertainty in international financial markets and imported inflation pressures need to be monitored closely. It is therefore clear that even though committed to bringing down inflation level of four per cent with upper tolerance band of six per cent, keeping in view the recent enhanced economic activity in manufacturing and services at 56.4 and 57.8 respectively, the central bank has paused for this meeting only.

Other factors like recent turbulence in banking sector in some advanced economics like USA and UK have brought financial stability in the global context to the forefront. Up to February, RBI kept the policy rate hike, albeit at a reduced pace. However, other central banks like US FED and Bank of England have increased their rates by quarter percentage point. It is to be watched the further future rate action by these Central Banks in view of the risks to financial stability witnessed by them.

Withdrawal of accommodation: The MPC also decided to remain focused on withdrawal of accommodation to ensure that inflation progressively aligns with the target, while supporting growth. While on one hand RBI has paused on the rate hike, while on other it continues to focus on withdrawal of accommodation. The Governor states that these rate increases have been fully transmitted to overnight weighted average call money rate (WACR), the operating target of monetary policy, which has gone up from a daily average of 3.32 per cent in March 2022 to 6.52 per cent this March. RBI has done large moderation in surplus liquidity. It is further indicated that RBI will remain flexible in meeting the productive requirements of the economy through the two-way operations as may be necessary. Non-food bank credit rose by 15.4 per cent (y-o-y) as on March 24, 2023 against the deposit growth of around nine per cent. The liquidity situation is likely to remain tight in the coming months. However, Das has stated that RBI will ensure completion of the government borrowing programme in a non- disruptive manner while maintaining orderly market conditions.

GDP growth estimation: With good monsoon, higher Rabi production, better agricultural sector and rural demand, the government continued to focus on capital expenditure and the resultant improvement in manufacturing and services sector and higher capacity utilisation are some of the reasons for the enhanced outlook on GDP front. Despite global headwinds, according to Commerce Minister Piyush Goyal, India’s goods and services exports may touch $750 billion in the year as at March 31-2023. The continuing geo-political tensions and recent financial market volatility are some of the risks to the outlook.

Financial stability: Another factor which has been under consideration is the recent turbulence in banking sector across advanced economies and the resultant financial stability challenges. While the central banks in those economies were fighting to tame inflation which is not yet over, are now confronted with new challenges relating to financial stability.

In this connection, the capital to Risk Weighted Assets Rate (CRAR) for the Indian banking system at 16.0 per cent as at end December 2022 remained well below the required minimum of 9.0 per cent. The Liquidity Coverage Ratio (LCR) of SCBs remained at 14.5 per cent in February 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 was 1.2 per cent last December.

While RBI keeping strict vigil on all of their regulated entities with macro and micro prudential measures with enhanced supervision and regulation, it is necessary in the light of what has happened elsewhere, at the sector level as well as individual regulate entities, to reassess and take pro-active steps to have much higher capital buffer and additional provisioning buffer. The RBI Governor has reiterated that “it is binding upon the regulated institutions to exercise due diligence in their risk management and corporate governance practices. They need to pay close attention to asset- liability mismatched and profile of their deposit base, while building up adequate capital buffers and conducting periodic stress tests “

I feel that RBI has taken the right decision to press pause button to provide more impetus to growth and also gauge the impact of past 250 basis increase in interest rates as full-fledged transmission of the increase in interest rates is yet to be fully got into the bank’s lending rates, though partial transmission has taken place. Meanwhile, as projected by RBI, inflation is projected to moderate at 5.2 per cent for 2023-24 with quarter projections also in the manageable level, the current pause in rate hike will augur well for the real economy and markets. However, RBI should not hesitate to take action to tame inflation if there any adverse developments coming from imported inflation, or domestic factors. Das states “We are confident that we are on track to bringing down inflation to the target rate over the medium term”.