Vijay Kumar Gaba

This statement was keenly watched, especially because of its timing. The RBI was expected to anticipate the impact of actions of the US Federal Reserve in their the intervening two meetings (14^th December and 1^st February 2023) and measures to be announced in the last full union budget to be presented before 2024 general elections scheduled to be announced on 1^st February 2023; and accordingly calibrate its policy stance.

The Monetary Policy Committee (MPC) of the RBI noted that—

(a)   The tightening of monetary policy by the global central bankers is causing the global growth to lose momentum and negatively impacting consumer confidence. The cost of living rising as inflation is persistent; though there are signs of pricing pressure easing due to monetary tightening.

(b)   Capital flows to emerging market economies remain volatile and global spillovers pose risks to growth prospects.

(c)    The inflation trajectory going ahead would be shaped by both global and domestic factors.

(d)   Adverse climate events – both domestic and global – are increasingly becoming a significant source of upside risk to food prices. Though global demand is weakening, unabating geopolitical tensions continue to impart uncertainty to the food and energy prices outlook.

(e)    The Indian economy faces accentuated headwinds from protracted geopolitical tensions, tightening global financial conditions and slowing external demand. Taking all these factors into consideration, the real GDP growth for 2022-23 is projected at 6.8 per cent with Q3 at 4.4 per cent and Q4 at 4.2 per cent, with risks evenly balanced.

(f)    Headline inflation is expected to remain above or close to the upper threshold in Q3 and Q4:2022-23. It is likely to moderate in H1:2023-24 but will still remain well above the target.

In view of the above, the MPC decided by a 5 to 1 vote, to hike the policy rates by 35 bps. Repo rate now stands at 6.25% and standing deposit facility rate (SDF), which is effectively the reverse repo rate, at 6%.

The MPC has also decided to maintain its “withdrawal of accommodation” stance by a 4 to 2 vote.

I also read the following in between the printed lines of the Monetary Policy Statement,

·         The dissent within MPC over the monetary policy stance is growing. There are some hints in the statement that points towards a “pause” with this 35 bps hike. The statement reads “the impact of monetary policy measures undertaken needs to be watched”. Besides, the MPC is now taking a “holistic view” of policy rates and liquidity relative to inflation. The governor mentions “Adjusted for inflation, the policy rate still remains accommodative”; implying that even a slightly higher inflation may not warrant further hike in rates.

·         The RBI has admitted that control over food and energy inflation may not be fully in the realm of monetary policy. It may hence have shifted its focus on core inflation. The statement reads “Calibrated monetary policy action is warranted to keep inflation expectations anchored, break the core inflation persistence and contain second round effects, so as to strengthen medium-term growth prospects.” This is perhaps what the RBI may have told the government in the letter written in November.

·         The statement says that liquidity conditions are comfortable with surplus system liquidity to the tune of Rs1.4lacs. It expects the conditions to ease further with festive season demand easing and foreign flows picking up. We may therefore see some more OMOs to withdraw liquidity in the next couple of few weeks. This would essentially mean further pressure on the banking system as the deposit-credit spread is tightening. We may see a rise in both deposit and lending rates. The key to watch would be AAA-GSec spreads that have not risen materially so far in this tightening cycle. A material widening of spreads could likely hit corporate credit demand and growth.

·         The RBI has assumed the Indian crude basket at US$100/bbl for making its projections for 2HFY23. This is significantly higher than the current crude price and appears counterintuitive to the narrative of slowing growth and poor consumer confidence. Also it does not seem to be factoring material rise in purchase of Russian crude at a steep discount to the prevailing market prices.

·         Governor Das emphasized on external stability in order to allay the fears of widening current account deficit and a FY13 type BoP crisis. This smoke may not be without fire. Governor said, “the INR - which is market-determined - should be allowed to find its level and that is what we have been striving to ensure. We must deal with the current global hurricane with confidence and endurance.” Obviously, it is willing to let USDINR move in a higher band. We may see RBI accumulating more USD, even if USDINR rises to beyond the current red line of 83.

·         The RBI forecast of FY23 real GDP growth at 6.8% is now lower than the recently upgraded World Bank forecast of 6.9%.

To conclude, I see higher rates (deposit, lending and corporate bond yields) and a weaker USDINR, post this policy statement.