RBI holds rates at 6.5%, on expected lines

Rate on hold, as expected

There was not much of a surprise element in the RBI June policy. The markets were already unanimous that RBI would maintain status quo on repo rates at 6.5%. The reasons were not far to seek. Since the RBI made a surprise decision to halt rate hikes in April, several favourable things happened. Consumer inflation fell to 4.7% in April and now the May inflation is expected to fall further to 4.34%. GDP growth for FY23 was robust at 7.2% with the fourth quarter surprising on the upside. Above all, despite warnings of monetary divergence, the RBI stuck to its stand and came out smarter. Industry is pleased with the halt in rate hikes, the markets are enthused and the FPIs are back to investing in India in droves. It was not surprising that the RBI decided to maintain status quo on rates at 6.5% in the June 2023 policy. 

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RBI Governor packs a punch in his speech

The RBI governor Shaktikanta Das is known for his penchant for old Hindi songs and his liking for quotes by the Mahatma. In the policy speech, the RBI governor focused on 4 key messages. The first message was that markets should not expect rate cuts any time soon, at least till inflation is well in the 4% zone. The second message is that the RBI would now focus more on liquidity and less on rates since surplus liquidity is the big story in the banking system. Thirdly, RBI feels that global growth concerns could neutralize some of the domestic macro robustness, which could impact GDP growth in the last two-quarters of FY24. Finally, RBI will now focus on bringing down core inflation. As Das summed it up in the words of the Mahatma, “If we are determined, we shall find the way that leads to our goal.” That is something Das has amply displayed.

Big announcements in the RBI policy statement

Here is a quick look at the gist of the Monetary Policy statement issued by the RBI.

1. Repo rates stay put at 6.50% and the vote was unanimous with all 6 members voting in favour of status quo on rates. Rates are now 135 bps above the pre-COVID rates. 
    
2. RBI has not tinkered with its stance on withdrawal of accommodation, largely due to surplus liquidity in the system. The vote was 5:1, with Jayanth Varma dissenting. 
    
3. This holds the pegged rates at the same level. The SDF rate stays put at 6.25%, while the bank rate and the MSF rate stay put at 6.75%. 
    
4. The policy was silent on further rate hikes or on peak rates. However, the RBI did rule out any rate cuts till inflation touched 4%. Rate hikes may be off the table for now. 
    
5. GDP projection for FY24 was retained at 6.5% as the RBI expects the global slowdown to offset the domestic economic vibrancy. The RBI upgraded GDP for Q1 and Q2 but cut GDP forecast for Q3 and Q4.
    
6. However, the RBI did cut its inflation forecast by 10 bps from 5.2% to 5.1% for FY24. The central bank has lowered inflation expectations for Q1 and Q2 of FY24 but it has kept the inflation expectations for Q3 and Q4 static. 

It is said that fortune favours the brave and the RBI did show a lot of courage in opting for status quo on rates in April. In retrospect, the decision turned out to be correct, as it kept corporates, markets, and global investors happy. In addition, inflation has come under control and growth is still robust. In a sense, RBI has been lucky, but this is the kind of good fortune that they truly deserved.

Why did RBI cut inflation but hold growth estimates?

RBI inflation forecast is the more exciting story, so we focus on that first. For FY24, the RBI MPC lowered the inflation estimates by 10 bps from 5.2% to 5.1%. It may be recollected that RBI had a cut-rate outlook by 10 bps in April also. The question is why is the RBI being so conservative in cutting inflation forecasts? There is a logic to it. While RBI expects tapering of wheat prices with Rabi mandi arrivals, Kharif output still remains an X-factor with monsoons getting delayed and a sub-par monsoon predicted. Also, the RBI stays concerned about core inflation. The inflation estimates for the next 4 quarters are Q1FY24 at 4.6%, Q2FY24 at 5.2%, Q3FY24 at 5.4% and Q4FY24 at 5.2%. Lower inflation in the first two-quarters of FY24 is being offset partially by flat inflation in the last two quarters.

Why did the RBI not hike growth estimates when FY24 GDP growth has come in at a robust level of 7.2%? While the RBI is confident about domestic demand and growth, it still expects that a global slowdown could crimp export demand. Hence export sectors and service sectors like IT could take a hit on account of the global slowdown. That is the reason, the RBI has maintained growth estimates at 6.5%. The GDP estimates for the next 4 quarters are Q1FY24 at 8.0%, Q2FY24 at 6.5%, Q3FY24 at 6.0% and Q4FY24 at 5.7%. Compared to April, the growth movements are neutral. While RBI has upgraded growth forecasts for Q1 and Q2, it has cut its growth forecast for Q3 and Q4; making it neutral overall for FY24.

What is the final takeaway from the RBI policy?

A few points emerge from the policy statement. The peak may have been called on rates, but rate cuts are still some time away. RBI stays concerned on the inflation front. However, RBI will stick to its April stand that enough has been done on the tightening front. Between now and the August policy, we have two more inflation and IIP readings plus credible data on monsoons. August policy could be more critical for the RBI.

Content Source: RBI Monetary Policy Statement