PL EcoFlash - RBI retains repo rate, 2Q Inflation expectations and El Nino a key risk

RBI retains repo rate, 2Q Inflation expectations and El Nino a key risk - Amnish Aggarwal - Head of Research, Prabhudas Lilladher Pvt Ltd

RBI retained repo rate at 6.5% and retained “Withdrawal of accommodation” stance while revising CPI target for FY24 by 30bps to 5.4% and GDP forecast at 6.5%. 2Q CPI forecast has been increased to 6.2% (5.2% earlier) with gradual moderation to 5.7% in 3Q (up 30bps) and 5.2% in 4Q (unchanged). RBI is banking upon limited impact of El-Nino and market interventions by GOI to control inflation in essential commodities, however we believe that there exists fair chance of 2Q/3Q inflation being higher than revised estimates of RBI. Although, the global economy has managed to sustain its moderate growth slowing economy in China, Technical recession in Germany, tighter financial conditions, unresolved geopolitical tensions, and banking sector vulnerabilities (esp. in the US) pose some drag to growth. We see risks to food grain production and Inflation which can pose some brakes on expected recovery in demand. However Industrial capex is showing signs of recovery which seems to be a silver lining in an uncertain scenario.

♦ The Monetary Policy Committee of RBI unanimously retained the key repo rate at 6.50% in its scheduled policy meeting on 10th Aug-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 Jun-23 meeting, the stance found support from 5 out of 6 members, with Prof. Jayanth R. Varma once again being the lone dissenter.

♦ The central bank retained its FY24 GDP growth forecast of 6.5% while revising its CPI inflation higher by 30 bps to 5.4%. There were modifications to the quarterly inflation forecasts - the revised estimates now stand at Q2 at 6.2% (From 5.2%), Q3 at 5.7% (From 5.4%), Q4 retained at 5.2%, and Q1 FY25 was introduced at 5.2%. GDP quarterly projections were left unchanged, but Q1 FY25 growth projection has been introduced at 6.6%.

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

Global Outlook

♦ Emerging comfort on sustainability of current account deficit and the need for impact assessment post the aggressive monetary tightening in last one year, appear to have wielded RBI’s decision to pause.

♦ Since the last policy review in June 2023, the global economy has managed to sustain its moderate growth momentum (barring noticeable downside to economic activity in China and emergence of a technical recession in Germany). Nevertheless, tighter financial conditions, unresolved geopolitical tensions, and banking sector vulnerabilities (esp. in the US) would continue to impart downside risk to global growth.

♦ IMF in its World Economic Outlook report published in Apr-23 revised down their forecast for 2023 and 2024 World GDP growth by 10 bps to 2.8% and 3.0% respectively. This will have some adverse spillover impact on India’s growth prospects in the near term, which would face additional headwinds from (i) the sharp monetary tightening by the RBI (315 bps of effective tightening since Apr-22), (ii) gradual fiscal consolidation, and (iii) likelihood of some disruption to monsoons from El Nino. Though a stronger recovery in private capex cycle, nascent signs of which are visible, if turns durable could lead to a minor upward bias to RBI's growth estimate.

Domestic Economy

♦ CPI Inflation in June 23 has seen impact of the dilution of favorable base and skyrocketing of vegetable prices like that of tomatoes over Jun-Jul-23 (so far), has imparted an upside risks to Q2 FY24 CPI. However, the RBI believes that such price rise will be temporary if the monsoon doesn’t show any significantly deviant behavior in Aug-Sep’23 due to the El Nino phenomenon. Clarity on the south-west monsoon progress in the coming weeks will give visibility on inflation.

♦ The 10-year bond yield was broadly unchanged post the policy announcement and was trading at 7.17% at the time of writing. Unlike few key central banks in developed economies that are yet to achieve their respective terminal rates in the current cycle, we do not expect any further rate hikes from RBI. We continue to expect some upward pressure on bond yields going forward, led by elevated US yields (risk of upward pressure if US CPI surprises on the higher side today), rising domestic inflation and global commodity prices. We see a range of 7.15%-7.25% for Q2. However, 10Y g-sec is likely to trade close to 7.00% levels by Mar-24 with some downside risk.

Other highlights

♦ Review of Regulatory Framework for Financial Benchmark Administrators: It has been decided to revise the extant regulations issued in June 2019 and put in place a comprehensive, risk-based framework for administration of financial benchmarks. This will cover all benchmarks related to foreign exchange, interest rates, money markets and government securities. The revised directions will provide greater assurance about the accuracy and integrity of financial benchmarks.

♦ Review of Regulatory Framework for Infrastructure Debt Fund - NBFCs (IDF-NBFCs): At present, Infrastructure Debt Funds (IDFs) provide refinancing facilities for lenders in the infrastructure sector. The extant regulatory framework for IDFs has been revised. The key changes in the revised framework are: (i) withdrawal of the requirement to have a sponsor for the IDFs; (ii) allowing IDFs to finance toll-operate-transfer (ToT) projects as direct lenders; (iii) permitting IDFs to raise funds through ECBs; and (iv) making tri-partite agreements optional for PPP projects. These changes are expected to augment the capacity for infrastructure financing in the country.

♦ Greater Transparency in Interest Rate Reset of Equated Monthly Instalments (EMI) based Floating Interest Loans: It is proposed to put in place a transparent framework for reset of interest rates on floating interest loans. The framework will require Regulated Entities to (i) clearly communicate with borrowers for resetting the tenor and/or EMI; (ii) provide options for switching to fixed rate loans or foreclosure of loans; (iii) disclose various charges incidental to the exercise of the options; and (iv) ensure proper communication of key information to borrowers. These measures will further strengthen consumer protection.

♦Conversational Payments and Off-line Capability on UPI; Enhancement in Transaction Limit of Small Value Off-line Digital Payments: With the objective of harnessing new technologies for enhancing the digital payments experience for users, it is proposed to (i) enable “Conversational Payments” on UPI, which will enable users to engage in conversation with AI-powered systems to make payments; (ii) introduce offline payments on UPI using Near Field Communication (NFC) technology through ‘UPI-Lite’ on-device wallet; and (iii) enhance the transaction limit for small value digital payments in off-line mode from ₹200 to ₹500 within the overall limit of ₹2000 per payment instrument. These initiatives will deepen the reach and use of digital payments in the country.

♦Public Tech Platform for Frictionless Credit: The Reserve Bank, in association with the Reserve Bank Innovation Hub (RBIH), started a pilot project in September 2022 for frictionless credit delivery through end-to-end digital processes, starting with Kisan Credit Card (KCC) loans. The pilot for KCC loans is currently operational in select districts of Madhya Pradesh, Tamil Nadu, Karnataka, UP and Maharashtra. Recently, dairy loans have been included in the pilot project in select districts of Gujarat. Based on the learnings from the pilots and to expand the scope of end-to-end digital lending processes, a Public Tech Platform for Frictionless Credit delivery is being developed by the RBIH. The Platform is intended to be rolled out as a pilot project in a calibrated manner. It will have an open architecture and open Application Programming Interface (API) and Standards, to which all financial sector players can connect seamlessly. This initiative will accelerate the penetration of credit to hitherto underserved regions and further deepen financial inclusion.