The Reserve Bank of India's decision to keep the policy repo rate unchanged at 6.5% came as a surprise against the consensus and our expectations of a 25 bps hike to 6.75%. The monetary policy stance remains accommodative, with a withdrawal bias.
The governor emphasized that the fight against inflation is far from over and hence, the pause was only for this meeting. The justification for this transient pause was that the central bank wants to assess the impact of the past rate hikes on inflation before taking additional tightening measures. In the current cycle, while the repo rate has been hiked by 250 basis points to 6.5%, the effective tightening has been larger; the average overnight call rate increased from 3.32% to 6.52% in March 2023.
The economic and financial stability outlook described by the governor is that of resilience and strength emanating from domestic impulses amid the intensifying global headwinds, which gives an impression of decoupling, a thesis that has been debunked long ago.
The real GDP growth projection for FY23E is kept unchanged at 7% and is expected to decelerate to 6.5% in FY24E, comprising 7.8% in Q1, 6.2% in Q2, 6.1% in Q3, and 5.9% in Q4.
On inflation, RBI expects gradual easing but upside risk remains due to the possible impact of weather anomalies on food supplies. At the same time, the moderation in global commodity prices and bumper rabi production, contributing to a healthy 6.2% rise in food grain production are dis-inflationary factors.
As a result, the projected retail CPI inflation for FY24 is placed at 5.2% (vs 5.3% earlier) comprising Q1 at 5.1%, Q2 at 5.4%, Q3 at 5.4%, and Q4 at 5.2%. Q1 projection has been revised upwards by 10 bps, while that of Q4 has been revised downwards by 40 bps.
Contributing to the outlook of economic resilience is the assessment of improving strength on the external sector front. These include narrowing current and trade account deficits due to falling trade, strong IT exports, and buoyant remittances, which have aided the revival of RBI's forex reserve balance. Accordingly, the Indian rupee has been stable.
Our assessment of Q3 FY23 BoP numbers indicates:
A high contribution to declining technology imports.
An abnormal surge in inbound and contraction in outbound travels.
A sporadic surge in banking capital inflows through the reduction of foreign assets.
RBI has emphasized the resilience of Indian banks and the NBFC sector due to micro and macro-prudential regulatory supervisory actions. However, this financial stability is not immune to the spillover impact of global financial turmoil. Hence, the supervisory regulation would need to focus on the root cause of vulnerabilities rather than the symptoms alone.
In our view, with RBI's resounding commitment to fight the sticky and elevated inflation on the one hand, the transient pause appears inconsistent. The multiple reinforcements that the fight against inflation is far from over along with the unchanged stance of remaining “withdrawal of accommodation” and a transient pause are creating confusing signals.
Hence, the expressed considerations for an episodic pause along the process of the fight against inflation and the guidance that it should not be construed as a pivot lack conviction.
So, the reasons behind this inconsistency probably lie in factors that are less overt.
First, despite the prolonged stickiness in inflation, the RBI may want to be more data-dependent in anticipation of downside inflation surprises.
Second, despite the optimism around domestic growth drivers, the actual scenario may turn weaker.
Third, notwithstanding the financial resilience emphasized by the RBI, a possible accentuation in tight global credit conditions in the U.S. and Europe, due to further flaring up of banking sector implosions can impact the Indian financial situation. Hence, the episodic pause should not be read as insularity from continued rate tightening by the Federal Reserve and the ECB.
Fourth, the pause may also serve as a facilitator for the government borrowing programme, which is heavy in the first half of the year, scheduled at Rs 8.8 trillion or 60% of the gross borrowing projection for FY24 at Rs 15.32 trillion.
Overall, RBI's mixed signals are possibly emanating from the above less overt considerations. Thus, with the guidance that the episodic pause does not overrule further rate hikes cycle, the possibility of the terminal rate rising to 7% remains.
A premature end of the tightening cycle at this juncture can imply:
Narrowing of the India-U.S. rate differential leading to currency pressures and outflows.
Persistence of high inflation.
Prolonging of the decline in saving rate and the domestic funding gap.
Considering the realities of moderating corporate performance and global developments, our market positioning characterized by a cautious stance on cyclical sectors, greater emphasis on domestic consumption themes, and some allocation in long-duration government bonds remains appropriate in our view.
Dhananjay Sinha is Co-Head of Equity and Research, Systematix Group.
The views expressed here are those of the author, and do not necessarily represent the views of BQ Prime or its editorial team.
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