RBI holds REPO rates at 6.5% In April policy

Tough monetary choices for the RBI

Ahead of the Monetary Policy announcement by the RBI on 06th April 2023, the RBI found itself in a strange predicament. It had diligently pursued the path of hawkishness for 11 months with 250 bps of rate hikes. However, consumer inflation continued to stay above the 6% mark. On the other hand, the spike in interest rates had compressed net margins of Indian companies in the third quarter and reduced its interest coverage. Clearly, it was time for the RBI to decide whether to persist with rate hikes or take a break.

The stage was simplified by the global banking crisis. In the first 2 weeks of March 2023, SVB Financial and Signature Bank of the US collapsed. It was soon followed by the slump sale of Credit Suisse to UBS. While bad asset decisions were the key reason for the crisis, the collapse was triggered by higher interest rates depleting bond portfolios. That, in itself, was a strong case for the RBI to go slow on rate hikes. That is exactly what it did in the April policy, holding repo rates at 6.5%.

What the status quo on repo rates means?

The status quo on rates must be read with the RBI comments and other macro data. Here are some key takeaways.

• With the status quo, benchmark repo rates stay at 6.50%. The street was betting on a nominal 25 bps rate hike, but the RBI has chosen to tread its own path. As a result of this status quo, the two linked rates also stay put. So, the SDF rate (formerly reverse repo) stayed at 6.25% and the bank rate and MSF (marginal standing facility) rate at 6.75%. 
  
   
• It would serve to take a historical perspective of rates. Since May 2022, the RBI has hiked rates on 6 occasions, taking the total rate hike to 250 bps. Effectively rates have gone up from 4% in May 2022 to 6.5% in February 2023. In addition, as the RBI governor pointed, the 40 bps higher set for SDF, makes the rate hike actually 290 basis points.
  
   
• The big question was whether this marked the end of the rate hike or it was just a pause. These are early days, but the RBI governor has underscored that the status quo of April was not indicative of the future trajectory of rates. The actual decision would depend on the global banking contagion and the stress that Indian companies feel from rising rates.
  
   
• The RBI has given positive undertones for GDP growth and inflation, albeit marginal. For instance, GDP estimate for FY24 has been upped by 10 bps from 6.4% to 6.5% for FY24. At the same time, the projected inflation for FY24 has been lowered by 10 bps from 5.3% to 5.2%. RBI is still betting on India being the fastest growing large economy.
  
   
• In a way, the RBI Monetary Policy Committee has shown adequate deference to the dissenting votes. In the last two policies, two MPC members; Ashima Goyal and Jayanth Varma had given a dissenting note on rate hikes. This move allays their concerns and also makes the MPC a receptive machinery rather than just a majority driven machinery.

Let us turn to what will drive higher growth and lower inflation in FY24?

Inflation and GDP growth for FY24

RBI lowered the inflation estimate for FY24 by 10 bps from 5.3% to 5.2%. Amidst a global slowdown, oil prices will remain under pressure. However, core inflation could face the lag impact of input costs. Lower current account deficit has also allowed the RBI to experiment with a pause in rate hikes, since the risk of imported inflation is much lower.

At the same time, RBI has also hiked GDP estimates raised by 10 bps from 6.4% to 6.5%? This is based on better than expected Rabi crop, which will drive higher agricultural output and a resultant consumption boom through rural demand. More importantly, higher rates do not seem to have dented the growth trajectory of the Indian economy.

A short pause or a long pause?

Will this entail a short pause or a long pause on rates? These are early days, but it would depend on how the global banking crisis shapes. It will also depend on the extent of stress faced by corporate India due to higher interest rates. This may be an experiment, but the RBI is keeping its options open. That is the right thing to do. This policy may mark a shift from the persistent hawkishness of the last one year.