Reserve Bank of India (RBI) Governor Shaktikanta Das will unveil the first monetary policy of the new financial year on April 6 after a two-day review. This comes amid a banking crisis in the United States and inflation concerns that threaten the pace of economic growth this fiscal.
As the banking crisis weighs on central bankers, the RBI, too, has its work cut out. The bi-monthly policy review by the six-member Monetary Policy Committee (MPC) led by Das will indicate the course the central bank will take in the financial year 2023-24 as it seeks to strengthen medium-term growth and curb inflation while battling global headwinds.
The US Federal Reserve moderated hawkishness after the shock collapse of the Silicon Valley Bank (SVB) sent ripples through the country’s banking system. Across the Atlantic, UBS’ take over of Credit Suisse hardly helped.
The goings-on in the banking industry also signals uncertainty for India’s growth even as high inflation continues to be a challenge for the rate-setting panel.
Some crucial domestic and global triggers that can influence RBI’s first monetary policy for FY24 are:
Domestic triggers
Food prices: Milk prices soared by 3-4 percent in maximum retail price (MRP) last month due to supply constraints and the trend is expected to continue in FY24. Sugar also surged 10 percent in March as the country reduced sugar exports.
Weather shock: The heatwave in February followed by unseasonal rains in March could affect crop production in the north, while cattle remained underfed due to high fodder prices. Cattle health and agriculture could be hit again if El Nino in April-May brings drought-like conditions.
Spike in COVID-19 cases: In the week gone by, India reported the biggest single-day spike of over 3,000 fresh coronavirus cases in nearly six months. Frontline workers have been put on “alert mode” and people advised to wear masks. Experts say that there is no reason to panic as hospitalisation remain low, so far.
Global triggers
Banking crisis: After the failure of SVB and Signature Bank, banking stocks in India faced selling pressure, as investors reduced their positions. This could lead to deprecation in the Indian rupee and a tightening of monetary policy.
Russia-Ukraine war: The war has crippled global supply chains, triggering high inflation rates across the world. The conflict has had a bearing on macroeconomic conditions in India, as prices of crude and food rose dramatically. A year on, the spill-over effect continues to be felt.
International crude oil prices: Even though global crude oil prices have slumped to the lowest in 20 months, petrol and diesel prices will not reduce anytime soon as state-run oil marketing companies (OMCs) still have to recover the accumulated losses due to high crude prices in earlier quarters.
What lies ahead
The RBI is expected to raise the interest rate by 25 basis points (bps) to 6.75 percent before leaving it at that level for the rest of the year, economists who participated in a poll conducted by news agency Reuters said.
If the central bank lifts the repo rate, the rate at which it lends short-term funds to banks, by 25 bps, then the new repo rate at 6.75 percent will sit at a seven-year high. One bps is one-hundredth of a percentage point.
If realised, it will mark a cumulative 275 basis point increase from the MPC since last May, a relatively modest rate cycle compared with some other central banks like the Fed, Reuters said.
Economists and financial analysts are divided whether the RBI should change its stance to “neutral” or persist with “withdrawal of accommodation”. Broadly, experts believe that the US banking crisis and evolving global scenario would largely dictate RBI’s stance.
Also Read: Retail inflation cools off to 6.44% in Feb on softening food prices
Here are the key indicators to watch out for during the MPC:
Inflation
Inflation in Asia’s third-largest economy remains above the central bank’s upper tolerance limit of 6 percent, reaching 6.52 percent in January and easing only slightly to 6.44 percent in February – a key reason for the RBI to hike interest rates again.
The minor 8 bps decline in February came after it rose far more than expected to January’s 6.52 percent. Retail inflation has stayed above the RBI’s medium-term target of 4 percent for 41 months in a row.
February’s inflation reading of 6.44 percent is the second consecutive month that it came in above 6 percent, taking the average for January-February to 6.5 percent, as against the RBI’s forecast of 5.7 percent. This piles pressure on the MPC to deliver another repo rate hike in the upcoming policy.
“Crude oil going up and down is unlikely to make any meaning to RBI’s inflation trajectory. Until and unless the government cuts fuel prices, but that is not going to happen. If that doesn’t happen, core inflation is unlikely to decline meaningfully to below 5.5 percent by the year-end. So, if we buy the argument of core inflation becoming sticky, we may have to see several rate hikes, and not just one in this policy,” said Soumya Kanti Ghosh, Group Chief Economic Advisor at State Bank of India (SBI) in an exclusive interview with CNBC-TV18.
“Inflation has not reacted to the monetary policy that has been carried out for the last two years,” noted Former Chief Statistician Dr Pronab Sen.
Also assessing the inflation scenario, Sonal Varma, managing director and chief economist at the Japanese securities house Nomura Financial Advisory said that the January-March inflation surprised on the upside, but a good chunk of that was actually because of sharp rise in cereals index.
“The forward-looking inflation trajectory is looking softer, commodity prices are down, and the global growth outlook is looking weaker. Domestic lead indicators are pointing towards slowdown in demand. We know that the monetary policy works with a lag, so the decision today cannot be based on yesterday’s data. It’s high time that the RBI policy becomes forward-looking,” Varma said told CNBC-TV18.
In a research report released last month, Nomura highlighted that markets are looking forward to a low inflation rate in FY24. However, this will mainly benefit the rural economy, it added.
Also Read: Global slowdown hits India, Nomura sees poor growth for next 2 years
Change of stance?
The country’s largest lender -SBI, in its recent report highlighted that RBI’s stance in the April meeting could continue to be withdrawal of accommodation and it can always keep the options open in June policy.
“RBI will have a delicate balancing job of either looking forward to the June meeting with clear signs of inflation trending downwards or looking backwards at the Jan and Feb prints in the April policy. Thus, it will be a delicate choice,” SBI noted in its research report.
Sajjid Chinoy, Chief India Economist at JP Morgan also believes that the balancing act for the RBI is the fact it has done over almost 300 bps of hike, and the monetary policy works with long and variable lags. So at some point, the RBI is going to have to stop and wait for previous hikes to filter through, he noted.
“Going forward, the RBI will become data-dependent, but at the same time still retaining the current stance. So, I expect the existing stance with certain tweaks. A switch to neutral would in a way offset the rate hike itself in terms of the impact it has on bond yields. The stance will be a balancing act if the RBI decides to hike rates,” Chinoy told CNBC-TV18.
However, Samiran Chakraborty, India chief economist at Citibank disagrees and voted for a change of stance to ‘neutral’, while speaking to CNBC-TV18.
“All of the accommodation that the RBI provided during the pandemic – whether it is on the rates front, or whether it is on the liquidity front, has now been withdrawn. It will be difficult for them to keep the withdrawal of accommodation phase, but neutral is a possibility. The neutral stance gives a greater flexibility and does not restrict new rate hikes. So, if there is a requirement for a rate hike, the RBI can still do it,” Chakraborty said.
Also Read: RBI to conduct 5-day Variable Rate Repo auction on March 24
Liquidity
Last month, the RBI announced that it conducted a five-day Variable Rate Repo (VRR) auction for a notified amount of Rs 75,000 crore upon review of current and evolving liquidity conditions.
The variable rate repo auction is done to inject liquidity into the banking system when it turns negative or is in deficit. Currently, liquidity in the banking system is estimated to be in deficit of around Rs 76,513.68 crore.
Brokerage firm Kotak Institutional Equities anticipates a 25-bps hike in the upcoming policy, followed by a cash reserve ratio (CRR) cut of 50 bps in mid-FY2024 to ease liquidity.
“When the fresh supply of government bond hits the market in April-May, but if for some there is not enough demand for it and yields start spiking up, the RBI can start doing some liquidity infusion operations through OMO to avoid any contagion effect, if the stance is neutral. From a withdrawal of accommodation stance, doing that will be very difficult,” said Citibank’s Chakraborty. OMO is short for Open Market Operation.
Also Read: RBI MPC: FY24 GDP growth seen at 6.4%, says Governor Shaktikanta Das
Growth
In the February MPC meeting, the rate-setting panel pegged the gross domestic product (GDP) growth for FY24 at 6.4 percent. “Economic activity in India remains resilient, while investment activity continues to gain traction, and rural demand continues to show signs of improvement,” Governor Das had said while announcing the MPC decision.
Citibank’s Chakraborty explained that as far as the global growth picture is concerned, the January-March quarter growth has been much higher, than what anyone could have anticipated.
‘’Because of high uncertainty, central bankers across the world are taking a view that they will pick up the pieces if something breaks, rather than taking a view that they will act before it breaks. So going forward, the monetary policy is going to be more reactive, rather than proactive. We expect the RBI to follow the same pattern,’’ said Chakraborty.
Assessing the economic conditions, Nomura anticipates a slowdown in growth in FY24 with chances of further downside in the following year.
“India’s Q4 2022 GDP growth was disappointing, moderating to 4.4 percent on-year from 6.3 percent in Q3. This is partly due to base effects and past revisions. That said, growth also slowed sequentially (to 1.0 percent from 1.8 percent in Q3),” said Nomura in its research report. The firm observed weaker momentum in domestic demand for private consumption as well as fixed investment.
‘’The good scenario would be that the policy responses done so far curtail any increase in financial stress which is our current baseline, but there is a risk that as rates stay higher for a longer period of time and growth slows down, we see more financial risk evolve.
Even in such a case, it is likely that banks are going to tighten their lending standards. Broadly, lending standards which were already being tightened even before SVB crisis happened, will be tightened further,’’ said Nomura’s Varma.
Also Read: Does RBI have a case for pause in April?
Overview
In its last monetary policy review held in February 2023, the RBI’s MPC raised the repo rate to 25 bps, taking the repo rate to 6.5 percent. Since last May, the MPC has hiked the policy rates by 250 bps to fight a persistently high inflation. While hiking the rate, the RBI reaffirmed its commitment to fight inflation but indicated that the nascent recovery in the economy needs policy support.
With fears of a global recession raging, in India too, there are escalating concerns on the growth front. India is expected to grow slower at 6.1 percent in 2023, compared with 6.8 percent in 2022, according to the International Monetary Fund (IMF).
The government has mandated the central bank to keep the inflation rate at 4 percent (+,- 2 percent). But, retail inflation has come in above RBI’s upper tolerance limit of 6 percent since the beginning of this year. As inflation continues to be a point of concern for the central bank, some experts reckon that the April rate hike of a modest 25 bps will be the last of its current rate hike cycle.
While several others feel that there is still a residual expectation of one more Fed rate hike in May and until that is behind, the RBI may not be very comfortable in signalling that they are done with the hikes.
