RBI policy limits to 35 bps rate hike in December

The December RBI policy came in an interesting background. After being incredibly hawkish for a better part of 2022, the US Federal Reserve had hinted that things could sober down. That was good news as the RBI would be able to tone down its aggressive rate hikes. Also, India’s Q2 GDP had come in much better than expected at 6.3%, despite global headwinds. However, inflation in India has a major imported component and that was the X-factor.

After having raised rates by 190 bps since May 2022, the RBI followed up with another 35 bps rate hike in December 2022, taking the repo rates to 6.25%. In a single move, the RBI has given out two key messages. Firstly, inflation is not going away so the fight against inflation will continue for now. Secondly, India’s GDP growth has been a picture of resilience if not decoupling; at least among the large economies in the world. 

Governor Das has a penchant for Bollywood one-liners and Mahatma Gandhi wisdom. In the December policy, he stuck to being an optimist, best captured by the Mahatma in his words, “Let no one think that something is impossible, just because it is difficult. If it is the highest goal, then the highest effort is warranted”. To an extent, the RBI must be able to pat itself in the back for 3 years of economic tumult well-managed. 

Key takeaways from the RBI policy announcement – December 2022

For a change, the RBI policy was exactly in sync with the street consensus. After hiking rate by 50 bps in the last 3 policies in succession, the RBI has given out the first signs of sobering.  

• RBI increased the repo rate by 35 basis points (0.35%) from 5.90% to 6.25% in the December policy. Repo rates are now 110 bps above the pre-COVID repo rate and the sobering indicates that terminal rates could be around 6.50%.

• What about the two repo linked rates ? The SDF rate (formerly reverse repo) is now at 6.00%; pegged 25 basis points below the repo rate. The bank rate and the MSF rate rise to 6.50%, pegged 25 bps above repo rates, hinting at higher cost of funds.

• The RBI has held inflation estimate for FY23 at 6.7% but cut GDP growth estimate for FY23 by 20 bps to 6.8%. The message is that a globally driven slowdown would keep commodity prices in check, restricting inflation growth. At the same time, the domestic colour of Indian markets will allow growth even amidst global headwinds.

• There is a greater divergence of views seen among MPC members. In fact, 5 out of 6 members voted to hike repo rates by 35 basis, with Jayant Varma dissenting. Withdrawal of accommodation got only 4 out of 6 votes with Ashima Goyal also joining Jayant Varma in opposing the resolution. The minute should offer a lot more clarity.

• 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 6.25%, it now looks like the RBI may be pencilling in a conservative repo rate target of 6.50% and a worse case repo rate target of 7.00% as the terminal rate. High transmission could be a concern.

MPC holds inflation estimate for FY23 at 6.7%

The inflation situation looks rather confusing at this point of time. For instance, the global commodity prices have been falling with Brent Crude now below $80/bbl. Also, weak China demand is a dampener. However, the disruption in the EU-Russia region is still big and any badly-set oil price cap can create chaos in global oil markets. At the same time, RBI is also wary of core inflation remaining sticky and supply chain constraints continuing to impact input costs. The positive news comes from higher acreage in 2022 Rabi sowing season.  

However, despite these positive signals, RBI underlined that a good deal of inflation could emanate from geopolitical risk and global risk factors. Also, Indian companies are under a lot of margin stress and price hike pass-on is likely to come aggressively in the next few months. That is also going to be intrinsically inflationary, which has dissuaded the RBI from reducing its inflation estimates. Consequently, the RBI has held full year FY23 inflation at 6.7%. This has been broken up as under: Q3FY23 at 6.6%, Q4FY23 at 5.9%, Q1FY24 at 5.0% and Q2FY24 at 5.4%. RBI expects inflation to be stable without falling significantly.

For the RBI, there are two factors that are closely related to inflation on a two-way street. The first is the trade deficit and the second is the USDINR equation. Let us talk about trade deficit. India is already slated to report record trade deficit for FY23 and that means a lot of imported inflation. The higher input costs are also hitting exports and widening the trade deficit. On the other hand, the spike in imports is weakening the USDINR to closer to 83/$ and the weak rupee also fuels imported inflation. It is this uncertainty with a global footprint that the RBI is really worried about.
 

FY23 GDP growth again cut by 20 bps to 6.8%
For the second policy in succession, the RBI cut its GDP estimates by 20 bps to 6.8% resulting in a total cut of 40 bps to GDP estimates in the last 2 policies. The GDP growth rate is now in sync with global estimates and any divergence from here could be on the upside. The GDP cuts are more an outcome of weak global demand and that has manifested in the form of weak exports across the board. Also, recent core sector numbers indicate that input cost inflation and higher interest costs are also putting a lid on expansion of output. These challenges are not going away in a hurry, with potential downside risks for GDP growth.

However, India has the advantage of resilience, if not decoupling from global markets. That is evident in the latest GDP numbers. The government thrust on capex and eventual revival in rural demand, combined with services sector growth could offset global growth risks. The reduced 6.8% GDP growth projection for FY23 and beyond has been broken up as under: Q3FY23 at 4.4%, Q4FY23 at 4.2%, Q4FY23 at 4.6% and Q1FY24 at 7.1% and Q2FY24 at 5.9%. This is the worst case scenario growth that looks likely in FY23.

Policy measures beyond monetary numbers

Now, the RBI monetary policy goes beyond rates, inflation, growth and liquidity. It is also used to signal key policy changes. Here are some major announcements made. 

• Banks can hold up to 23% of NDTL as SLR in HTM (held to maturity category) till March 2023; enhanced from 19.5%. Now, RBI has extended this limit up to March 2024. HTM classification allows greater portfolio flexibility amidst volatile interest rates.

• RBI will now introduce single-block and multiple-block debit functionality in UPI transactions, considering its rapid growth. IN addition, the Bharat Bill Payments System (BBPS) will develop capabilities for handling recurring transactions as well.

• In an interesting move, resident Indians with exposure to gold can hedge their risk in global markets. However, one has to use the IFSC route for this purpose since both NSE and BSE have a link up to IFSC.

RBI has played it safe ahead of November inflation and US Fed policy. But the message is that now RBI is more willing to talk the language of growth.