The RBI has left the policy repo rate unchanged at 6.5% in its first bi-monthly policy meeting and maintained the
LAF corridor at 50 bps. The stance was maintained at ‘withdrawal of accommodation’ keeping the window open for
further monetary policy tightening if required. The Central Bank also re-emphasized its commitment towards
ensuring price and financial stability with a progressive movement towards the 4% medium-term inflation target.
The narrative of policy rate actions having a lagged impact on the inflation and expectation of lower CPI inflation
in FY24 has supported the RBI’s decision despite the spike in retail inflation above 6% in Jan and Feb. Talking of
growth, the strength in high-frequency growth indicators have supported the growth momentum so far. However,
the spillovers of global demand slowdown are visible in India’s trade and manufacturing sector’s performance. The
global turbulence and economic uncertainties could adversely impact investors’ appetite resulting in muted private
investment. Further, the weather-related uncertainties could limit the rebound in rural demand. With these
challenges emerging on the growth front, RBI has chosen to put a brake on the policy tightening cycle.
The Central Bank has hiked the repo rate by 250 bps so far but has been dialling down the pace of hikes since
December gaining comfort from the sustained moderation in commodity prices. While the decision to pause in the
April meeting was unanimous, the dissent on keeping the stance at ‘withdrawal of accommodation’ continued.
The growth forecast for FY24 was revised upwards by 10 basis points to 6.5%. The inflation projection was revised
lower to 5.2% (from earlier projection of 5.3%) mainly due to base adjustment in the fourth quarter.
A detailed look into all the variables that could have influenced RBI’s policy decision is presented below:
Inflation Set to Moderate in FY24
The average consumer inflation has overshot RBI’s upper band in the last four quarters. The Q4 FY23 number is expected to be 50 bps higher than the RBI’s estimate of 5.7% due to a spike in food inflation in Jan and Feb. However, starting in March, CPI inflation is expected to trend lower supported by the base effect and easing WPI inflation. The impact of past rate hikes and demand normalisation will also help to bring core inflation down below 6%. The estimate of record food grain production (including wheat) in the crop year 2022-23 could relieve food inflation. That said, the Central Bank will be vigilant due to the upside risks to inflation arising from the possibility of weather-related shocks and any further spike in global crude oil prices.
Risks on Growth Front Balanced
While domestic economic activity has largely sustained momentum, the impact of the global slowdown is visible in some segments. The manufacturing sector’s output has contracted in the previous two quarters, merchandise exports have been weak while non-oil imports have fallen for three months in a row. The unfavourable global economic conditions have also weighed on India Inc’s financial performance in Q3 with moderation in sales growth and muted growth in profitability. The recent bank failures in the major economies have aggravated the concerns surrounding the global growth slowdown. Recently, many international organisations have lowered India’s growth projection for FY24 accounting for these emerging challenges. However, the economy is still expected to grow by 6.1% (CareEdge projection) on the back of strength in private consumption and a pick-up in private investment. As the private sector has been slow so far with their capex plans due to an uncertain economic environment and tight financial conditions, a relief on account of a pause in rate hikes would be encouraging to propel private investment cycle.
Rupee Outlook Positive, External Vulnerabilities Contained
Though the rupee has been under pressure in FY23 due to sharper rate hikes by the Federal Reserve and financial uncertainties, the outlook for FY24 remains positive. The India-US yield differential has improved in the last few months and is expected to remain around the same level with Federal Reserve likely to pause after a 25-bps hike in May. Also, the current account deficit (CAD) is expected to improve in FY24 due to the easing of commodity prices, upbeat services exports
and healthy remittances. We expect CAD to moderate to 1.6% of GDP in FY24 from an estimated 2.1% in FY23. A combination of these factors along with a comfortable level of forex reserve buffer will support the Indian rupee.
Liquidity Under Pressure, Real Rate Positive
As a result of RBI’s liquidity tightening measures and strong credit demand, the liquidity in the banking system has
been moderating. It slipped into deficit in recent months on account of advance tax payments, and LTRO and
TLTRO redemptions. This led to a sharp rise in short-tenor bond yields and a flattening of the bond yield curve.
The tight liquidity conditions have driven the call money rate above the repo rate in March. In the coming months
too, liquidity is expected to remain pressured due to TLTRO redemptions scheduled in April. In view of supporting
growth, the Central Bank would ensure liquidity at adequate levels. It has already injected Rs 1.89 lakh crore
through variable repo rate operations between Feb 10 and March 24. The pressured liquidity conditions and positive
real rate supports today’s pause. The real policy rate (repo rate adjusted for one year ahead of inflation) stands
near 1.3% currently.
Way Forward
While RBI has paused on the policy rate front, it has also strongly reiterated its commitment to bringing down
inflation close to its medium-term target of 4%. Given the uncertain global environment and lingering risks to
inflation, Central Bank has kept the window open for further monetary policy tightening in future if required.
However, with inflation likely to trend downward from the current level, it is unlikely that RBI will have to hike rates
further in 2023. We expect a status quo in the policy rate in 2023. With GDP growth above 6% and CPI inflation
likely to remain higher than RBI’s 4% target, we do not see the scope of any rate cut in FY24.
