PL EcoFlash - RBI Maintains Repo Rate; Announces OMO Sales as Inflationary Pressures Loom

RBI retained repo rate at 6.5% and maintained the “Withdrawal of accommodation” stance, anchored in its commitment to achieve a medium-term CPI inflation target of 4%, while also supporting growth. This sentiment was further echoed in their liquidity measures, notably the decision on OMO sales, to fine-tune liquidity management and ensure effective policy rate transmission. For FY24, GDP growth is pegged at 6.5%, with a slight uptick for Q3FY24 to 6.3%. The CPI forecast remains at 5.4% for FY24, though Q2FY24 saw a minor revision to 6.4%. The central bank's vigilance is palpable, especially with July's CPI inflation peak of 7.4%, driven by factors like supply chain disruptions, diminished Kharif sowing, and global commodity price hikes. However, optimism prevails as the RBI expects the recent harvest season and governmental measures to alleviate food inflation. While India's growth trajectory is promising, underpinned by strong domestic fundamentals, global challenges, including geopolitical unrest and market volatility, loom large. In this intricate scenario, the RBI's stance is unequivocal: it's poised to navigate India's growth journey with caution, adaptability, and foresight.

- The Monetary Policy Committee of RBI unanimously retained the key repo rate at 6.50% in its scheduled policy meeting on 6th Oct-23

- The policy stance was retained, with the MPC deciding "to remain focused on withdrawal of accommodation to ensure that inflation progressively aligns with the target, while supporting growth". Like the outcome in Aug-23 meeting, the stance found support from 5 out of 6 members, with Prof. Jayanth R. Varma once again likely being the lone dissenter.

- Delving into the projections, for FY24, the RBI's GDP growth estimate remains at 6.5%, with the CPI projection unchanged at 5.4%. Quarterly data shows GDP for Q3FY24 adjusted from 6.0% to 6.3%. CPI for FY24 stands at 5.4%, with Q2FY24 revised upwards from 6.2% to 6.4% and Q3FY24 from 5.7% to 5.6%.

- Notwithstanding the widely anticipated status quo on policy rate and stance, the RBI's announcement of Open Market Operation (OMO) sales came as a surprise, adding a hawkish tint to the policy. While the specific OMO calendar has not been released, the Governor, in the post-policy press conference, emphasized the bank's intent for "active liquidity management." This signals the RBI's inclination towards tighter liquidity conditions in the future, influenced by both inflation risks and financial stability concerns. This stance is in alignment with the central bank's objective of anchoring inflation at 4%. The RBI's approach is clear: merely keeping inflation below the upper band of the target range (at 6%) is insufficient; a more proactive approach is essential.

- The governor emphasized that despite apparent short-term deficits, the overall liquidity scenario is in surplus. This surplus, he explained, becomes evident when considering the net impact after adjusting for seasonal factors like tax outflows and the withdrawal of the 2000 Rs note.

- The liquidity landscape is shaped by a myriad of factors. While the reversal of ICRR and heightened government spending are expected to augment liquidity, this could be offset by an increased demand for currency, especially during the festive season and in the run-up to elections, and any potential FX interventions by the RBI to support the rupee.

- The RBI's objective is to maintain a delicate balance in liquidity conditions, ensuring that the Weighted Average Call Rate (WACR) remains close to or slightly above the repo rate. Although there was a liquidity deficit of INR 22,000 crore as of 5th October, it's a significant improvement from the over INR 1 lakh crore deficit seen at September's end. The central bank's projection indicates liquidity levels ranging between INR -0.25 to +0.5 lakh crore in the upcoming months.

- Withdrawal of Rs 2000 banknote from circulation increased core liquidity as ~87% of the returned notes were in the form of bank deposits.

- RBI is likely to maintain a prolonged pause with the repo rate unchanged at 6.50% through FY24.

Global Outlook

- RBI's pause seems to be shaped by its growing confidence in the sustainability of the current account deficit, coupled with a desire to assess the repercussions of the rigorous monetary tightening undertaken over the past year.

- Since the last policy review in August 2023, the global economic landscape has witnessed significant shifts:

The US is witnessing its yields soaring to levels unseen since 2007, reaching close to 4.6%. This ascent is driven by a persistent 'higher for longer' stance on monetary policy. The Fed could still opt for one more round of final rate hike, thereby supporting the USD. The upcoming FOMC review on Sep 20th will update the dot plot and hopefully provide clarity on the terminal rate (market participants currently stand divided on the prospect of another rate hike).

Notwithstanding recent improvement in Chinese economic data, the trend so far suggests dominance of downward surprises. This has put pressure on the CNY, which is also weighed down by PBoC easing.

The global commodity landscape is feeling the heat, especially with crude oil prices. They've spiked due to OPEC's decision to extend its supply cut, coupled with China's monetary easing measures.

The global growth trajectory remains positive, with the US leading the charge, diminishing earlier recession fears. However, a deceleration in growth momentum is anticipated as we approach H2-2023, given the frailty in global trade.

Non-farm payroll run-rate has dipped substantially over the last 3 months (150k) compared to the previous 3 months (430k)

Increase in Russian crude oil prices, surpassing the G7's implied cap, is beginning to diminish the strategic advantage previously benefiting India's current account.

Domestic Economy

- CPI in Aug-23 moderated slightly more than expected to 6.83%YoY from a 15-month high of 7.44% in Jul23. On the other hand, while being in negative territory, WPI inflation increased to a 5-month high of -0.52% YoY from - 1.36% in Jul-23. Sequentially, CPI fell by 0.05% MoM, mainly driven by drop in increased vegetable prices. It was sharply lower than the series average of 0.70% MoM jump, usually seen in the month of August. Moreover, this is the first time that the index moved lower in August.

- CPI Inflation in Aug- 23 has seen relief emanating from the food basket, which saw 0.52% MoM fall, led by Vegetables, Egg and Meat & Fish. Tomatoes (with a ~22% MoM fall) dominated the price move in the Vegetable index, as supply started responding to the build-up in price since Jun-23. Nevertheless, limiting the decline in overall food inflation was continued price pressure seen from Cereals and Pulses, which remain on watch in the near term.

- On the domestic front, notwithstanding some moderation, inflation expectations continue to remain above pre Covid levels, with several upside risks warranting attention. The OPEC+ resolution to persist with production cuts is exerting upward pressure on crude oil prices. Concurrently, global commodity prices, particularly food, are escalating due to the termination of the Ukraine grain deal and India's rice export ban. The looming El Nino threatens global food production, potentially intensifying these price surges. Domestically, despite the government's administrative interventions like open market sales and stockholding limits, the persistent price strains in cereals and pulses remain concerning. The erratic monsoon patterns further cloud the outlook, impacting Kharif crop yields and Rabi sowing. However, a silver lining emerges with the recent Rs 200 reduction in LPG cylinder prices, anticipated to moderate the September CPI by approximately 30-35 bps.

- Concurring with the RBI's projections of GDP at 6.5% for FY24, we identify four pivotal factors that could influence growth estimates. Firstly, the impending global slowdown, although slightly deferred, could have negative repercussions on our economy. Secondly, the diminishing pent-up demand, particularly in services, might act as a drag. Thirdly, the residual effects of domestic monetary tightening could potentially dampen leveraged urban demand, especially for goods. Lastly, the looming El Nino poses heightened weather risks, threatening not just the Southwest monsoon but also the winter rainfall, which could impact agricultural output and overall economic momentum.

- Strength in domestic consumption has been accompanied by continued improvement in capacity utilisation level, standing at 76.3% as of Mar-23 as per RBI’s OBICUS survey. This is allowing a nascent recovery in private capex to take shape in select sectors (especially auto, infra)

- Post-policy, the 10-year bond yield surged by 15 bps to 7.36%, reacting to the central bank's openness to future OMO sales. The Governor emphasized that OMO sales aim to manage liquidity based on domestic conditions, not as a yield management tool. However, the chosen liquidity management instrument, OMO operations, undeniably influences yields. While today's spike in the 10-year yield might seem overstated and could slightly retract, the trajectory suggests a higher trading range. Anticipated influences include global yield pressures, potential OMO sales, and global food and energy price risks, positioning the 10-year bond yield to oscillate between 7.25-7.35%.

Other highlights

- Introduction of New Channels for Card-on-File Tokenisation (CoFT): Given the growing acceptance and benefits of tokenisation of card data, it is now proposed to introduce Card-on-File Tokenisation (CoFT) creation facilities directly at the issuer bank level. This measure will enhance convenience for cardholders to get tokens created and linked to their existing accounts with various e-commerce applications.

- Payments Infrastructure Development Fund – Extension of Scheme and Inclusion of PM Vishwakarma Scheme Beneficiaries: Since its launch in January 2021, the Payments Infrastructure Development Fund (PIDF) Scheme has enabled over 2.66 crore new payment touch points across the country. It has been decided to extend the scheme by two years, i.e., up to December 31, 2025. The coverage of PIDF scheme is also being expanded (i) to include the beneficiaries of PM Vishwakarma Scheme; and (ii) to deploy emerging modes of payment acceptance, such as soundbox and Aadhaar-enabled biometric payment acceptance devices. These measures will further accelerate the Reserve Bank’s efforts to promote digital payments at the grass root level.

- Gold Loan – Bullet Repayment Scheme – UCBs: It has been decided to increase the existing limit for Gold Loans under the Bullet Repayment scheme from ₹2 lakh to ₹4 lakh in respect of Urban Co-operative Banks (UCBs) who have met the overall target and sub-targets under the Priority Sector Lending (PSL) as on March 31, 2023. This measure is in pursuance of our earlier announcement that suitable incentives shall be provided to UCBs that have met the prescribed PSL targets as on March 31, 2023.

- Credit Concentration Norms – Credit Risk Transfer: At present, under the Large Exposures Framework, NBFCs in the Upper Layer are permitted to use Credit Risk Mitigation (CRM) instruments for reducing their exposures to a counterparty. With a view to harmonise the credit concentration norms among NBFCs, it has been decided to also permit NBFCs in the Middle and Base Layers to use CRM instruments for reducing their counterparty exposure under the credit concentration norms.

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