RBI Monetary Policy : Fight continues against inflation

Broadly in line with expectations, the Monetary Policy Committee of RBI has raised the benchmark repo rate by 50 bps to 5.40% in its scheduled policy meeting on Aug 5, 2022. This marked the second consecutive 50 bps hike; taking the cumulative rate hike to 140 bps since May-22. With the latest move, the current repo rate now stands above the pre-pandemic level of 5.15%. SDF and MSF rate i.e., the lower and upper bound of the LAF corridor have been adjusted upwards to 5.15% and 5.65% respectively.

The 50-bps rate hike was unanimous, backed by all members of the Monetary Policy Committee (MPC) who decided to "remain focused on withdrawal of accommodation to ensure that inflation remains within the target going forward, while supporting growth”.

Economic outlook

With respect to FY23 economic outlook -

• RBI retained the GDP growth forecast at 7.2%. On a quarterly basis, it estimates growth at 16.2% in Q1, 6.2% in Q2, 4.1% in Q3, and 4.0% in Q4 – same as before. Forecast for Q1 FY24 was introduced at 6.7% which appear to be abruptly high vis-à-vis the previous quarters.
• On CPI inflation, RBI retained its FY23 forecast at 6.7%. On quarterly basis, the forecasts for Q2 and Q3 saw marginal tweaks – 7.1% in Q2 (from 7.4% earlier), 6.4% in Q3 (from 6.2% earlier), and 5.8% in Q4 (from 5.1% earlier). The forecast for Q1 FY24 is estimated at 5.0%.
• As per RBI’s assessment, CPI inflation has already peaked in Jun-22 and is expected to revert within RBI’s inflation target band in Q4 FY23 i.e., after a gap of five quarters.

Key takeaways

Two positive developments have taken shape since the last monetary policy announcement in Jun-22:

• One, a sizeable moderation in global commodity prices. The Reuters CRB Index is down around 14.5% since Jun-22 peak which is likely to translate into inflation reprieve for a net commodity importing country such as India. However, on net basis, the gains could be somewhat lower, given the depreciation in Rupee by 1.9% over the same period.
• The turnaround in Southwest monsoon, with cumulative rainfall for the season swinging from a deficit of 8% of LPA as of end Jun-22 into a surplus of 6% (as of the first week of Aug-22). While uneven distribution is believed to have weighed on Kharif sowing, especially the acreage under Rice (due to significant shortfall in states of UP, WB and Bihar) – the official data has not been released since mid-July-22 to validate the same.

On the other side, global growth outlook has worsened materially. IMF in its latest World Economic Outlook, downgraded world GDP growth for 2022 further by 40 bps to 3.2% and for 2023 by 90 bps to 2.9% (i.e., compared to Apr-22 estimates). This is likely to exert a downward impact on growth on India (via exports), and also imply weakness in Rupee amidst the expansion in the current account deficit. While we hold on to our FY23 GDP growth estimate of 7.5%, the pace of global growth slowdown remains on close watch.

On inflation, we are in agreement with RBI’s estimate of 6.7% for FY23. Akin to RBI, we continue to hold on to our inflation estimate despite the sizeable downside to global commodity prices. This is largely because of:

• Several pipeline inflationary pressures – such as GST rate hikes on some items of mass food consumption, upward revision to electricity tariffs in some states, along with MSP revisions –yet to be formally captured in data
• The downside in global commodity prices, is likely to have a bigger impact on WPI inflation vis-à-vis CPI inflation
• Continued recovery in services, amidst high vaccination coverage to add to services inflation

In addition, despite H2 FY23 trajectory seeing a sharper correction as per RBI’s own estimate (6.10% in H2 vs. 7.20% in H1), overall CPI inflation for FY23 will remain elevated at 6.7%. While there is still a scope of another 50-60 bps of rate hike in the current year in line with the need to frontload rate hikes in tandem with global central banks, the pace of the residual hike will also depend on the inflation print over the next few months. The rate action is likely to be accompanied by simultaneous withdrawal of money market core liquidity surplus. RBI, however, indicated its preference for two-way fine-tuning operations through VRR and VRRR options whenever required and this has been in evidence in the last week of July-22. We believe core liquidity surplus could moderate towards 1.0/1.5% of NDTL levels from 2.8% currently.

Given the hike in the benchmark rates, there will be a further hike in the domestic lending and the deposit rates in the near term. All the loans linked directly with the repo rates will have the pricing reset with immediate effect. While deposit rates have inched up gradually, it is likely to pick up pace over the current and next quarter with the visible pickup in credit growth. We expect bank deposit rates to increase by 50-100 bps by Dec-22. This will ensure that monetary transmission takes place beyond the loans that are linked with the repo rate.

With the swift and sizeable correction in global commodity prices (and possibility of domestic inflation having peaked) and deceleration in global growth prospects, we now revise lower our 10Y g-sec yield expectation. The 10Y g-sec yield is likely to have peaked out with possibility of range bound trading between 7.20-7.60% levels in the remaining months of FY23.