RBI limits rate hike to 25 bps on falling inflation

Monetary policy backdrop – February 2023

The February 2023 monetary policy of the RBI marks the first policy announcement for the calendar year. It also comes in the midst of interesting circumstances. The RBI could afford to go slow since central banks like the US have also been tapering on rate hikes and domestic inflation has been falling. However, with the Fed guiding for more rate hikes in future, the RBI had its task cut out. It had to hike rates, albeit marginally, to send the right signal to the market that the battle against inflation was still on. And, signal it did!

After having raised rates by 225 bps since May 2022, the RBI followed up with another 25 bps rate hike in February 2023, taking the repo rates to 6.50%. In a single move, the RBI has given out two key messages simultaneously. On the one hand, inflation is not going away, so the fight against inflation will continue. Secondly, GDP growth has been upgraded to 7% for FY23 and India is already likely to be the fastest growing large economy in the world.

If one thought that Governor Das had a penchant for Mahatma Gandhi one-liners, he took a departure to the other extreme and quoted Netaji Subhash Chandra Bose. “Never lose your faith in the destiny of India”. If it reminds you of Warren Buffett warning investors not to bet against America, you are not off the mark. Amidst the global chaos and economic tumult, India and the US are the two economies that have come out stronger and smarter.

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Major takeaways from the RBI policy – February 2023

This time around, the markets had already factored in a 25 bps rate hike and the outcome and the language of the RBI policy statement was largely along expected lines. Here are some key takeaways.

• RBI increased the repo rate by 25 basis points (0.25%) from 6.25% to 6.50% in the February 2023 policy. Repo rates are now 135 bps above the pre-COVID repo rate. Rates are now up 250 bps since May 2022.
• The SDF rate (reverse repo) is at 6.25%; pegged 25 basis points below the repo rate. The bank rate and the MSF rate rise to 6.75%, pegged 25 bps above repo rates. The RBI has also withdrawn the accommodative policy stance in its entirety effective this policy.
• The RBI has cut the inflation estimates for FY23 by 20 bps from 6.7% to 6.5%. At the same time, the GDP growth estimate for FY23 has been hiked by 20 bps from 6.8% to 7.0%. This is a dual benefit for the markets. RBI has assumed oil at $95/bbl, so actual inflation may end up being even lower than that.
• There is greater divergence of views seen among MPC members. Only 4 out of 6 members of the MPC voted in favour of both resolutions. Dr Ashima Goyal and Prof Jayanth Varma voted against the decision to hike rates by 25 bps and also against the decision to withdraw accommodative stance.
• In the previous MPC meet, there was an indirect reference to raising terminal rates for repo from 6% to 6.50%. With rates already at 6.50% and the RBI still unwilling to call a peak on rates, it looks like the terminal rates would now converge closer to the 7% mark. A lot predicates on how the Fed, ECB and Bank of England deal with inflation. 
  Overall, the policy has left the markets and investors with a feel-good factor since the growth estimates have been raised by 20 bps and inflation lowered by 20 bps for FY23.
   

MPC cuts inflation estimate for FY23 to 6.5%

Since the last monetary policy announcement in December 2022, the price of Brent crude has remained around $80/bbl mark. The current inflation estimate for FY23 has been lowered by 20 bps from 6.7% to 6.5%. The good news is that the current inflation assumption at 6.5% is based on the premise that crude oil would be at $95/bbl, which is nearly 20% above the current rates. So, there is scope for inflation to actually come down further. RBI has expressed concerns over core inflation remaining sticky and supply chain constraints continuing to impact input costs. A lot will depend on the Rabi sowing season. 

RBI underlined that a good deal of inflation risk could emanate from core inflation. In the last few months, the fall in inflation has been largely driven by a sharp fall in the vegetables basket. Also, the risk to cereals remains as Kharif output has been below average and Rabi details are yet to come in. However, RBI has decided it is time to cut the FY23 inflation by 20 bps to 6.5%. The break-up: Q4FY23 at 5.7%, Q1FY24 at 5.0%, Q2FY24 at 5.4% and Q3FY24 at 5.4% and Q4FY24 at 5.6%. FY24 inflation has been pegged at 5.3%.

The one factor that India has to be wary of is imported inflation; which comes in two forms. It comes as global commodity inflation being imported into India. It also comes from a weaker rupee and as we have seen in the last few days, the rupee has weakened closer to 83/$, even though the dollar index is way below its peak levels of 114. 

FY23 GDP growth raised by 20 bps to 7.0%

Exactly 2 months back in the December 2022 policy, the RBI had cut GDP growth estimate by 20 bps from 7.0% to 6.8%. In the February 2022 policy, the situation has been reversed as the GDP estimate for FY23 has been again hiked back to 7.0%. This decision was triggered by a better than expected global recovery, strong real GDP growth numbers in the US, first estimates of GDP by MOSPI pegged at 7.0% and reinforced by optimism that the IMF and World Bank had pegged India as the fastest growing economy in FY23 and FY24.

However, India has the advantage of resilience, if not decoupling from global markets. The Union Budget must have come as a whiff of fresh air with outlay of Rs10 trillion for capex and reduction in fiscal deficit to 5.9% of GDP. The enhanced 7.0% GDP growth projection for FY23 has also been topped up with 6.4% GDP growth projection for FY24. Here is the break-up of FY24 GDP growth quarter-wise. GDP growth is projected as: Q1FY24 at 7.8%, Q2FY24 at 6.2%, Q3FY24 at 7.8% and Q4FY24 at 6.2%. 

Some policy measures beyond monetary metrics

RBI monetary policy goes beyond monetary numbers and also signals key shifts at a macro policy level. Here are some key announcements.

• RBI proposes to permit securities borrowing and lending mechanism in government securities, on the lines of the scheme already available for stocks.
• RBI proposes to expand the scope of the Trade Receivables Discounting System (TREDS). It proposes to extend insurance facility on TREDS for MSMEs.
• UPI (unified payment interface) will be extended for inbound travellers to India. RBI is already working on providing UPI facilities to NRIs is select countries on a pilot basis. It would be restricted to travellers from G-20 countries to begin with.
• RBI is thinking of a QR based coin vending machine (QRCVM) to ensure distribution of coins as a cashless facility via direct debit to banks.

The willingness to cut inflation and hike growth targets for FY23 shows aggression and confidence in the RBI that Indian economy may have already traversed the riskiest part of the journey.