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As expected, interest rates on home, vehicle, personal and other loans in the banking system will remain unchanged with the six-member Monetary Policy Committee (MPC) of the Reserve Bank of India (RBI) keeping the main policy instrument, repo rate, unchanged at 6.5 per cent in a 5:1 majority decision in its bi-monthly policy review.
The central bank also retained the stance of the monetary policy as ‘withdrawal of accommodation’ in a 5:1 majority decision. The central bank has retained the headline inflation forecast at 5.4 per cent for the current fiscal as uncertainty persists on the food prices front.
However, Jayanth Varma, member of the MPC, differed with other members and voted for 25 basis points (bps) reduction in repo rate and changing the policy stance to ‘neutral’ from ‘withdrawal of accommodation’.
Interest rates on loans and deposits are largely likely to remain unchanged as of now. Certain segments of the retail loans are expected to cost more as the RBI recently hiked the risk weights on retail loans and many banks raised marginal cost of fund-based lending rate (MCLR). All external benchmark lending rates that are linked to the repo rate will not rise. It will provide some relief to borrowers as their equated monthly instalments (EMIs) will not rise.
However, as banks are under pressure on the deposit growth front due to competition from mutual funds, deposit rates are likely to rise in certain buckets.
The six-member rate-setting panel, headed by Governor Shaktikanta Das, has decided not to tinker with the repo rate — the rate at which RBI lends money to banks to meet their short-term funding needs — to manage and balance the retail inflation and growth.
A major reason for the continual pause in the repo rate hike is because retail inflation continues to remain above the 4 per cent target of the RBI. Retail inflation (CPI) rose to 5.55 per cent in November from 4.87 per cent in October and 5.02 per cent in September, and further reached 5.69 per cent in December. Even in FY25, the RBI has forecast a 4.5 per cent retail inflation.
“Going forward, the inflation trajectory would be shaped by the evolving food inflation outlook. Rabi sowing has surpassed last year’s level. The usual seasonal correction in vegetable prices is continuing, though unevenly. Yet considerable uncertainty prevails on the food price outlook from the possibility of adverse weather events,” Das said.
This is the sixth monetary policy on the trot when the MPC has kept the repo rate unchanged at 6.5 per cent. Last time, the repo rate was raised from 6.25 per cent to 6.5 per cent in February 2023.
Anu Aggarwal, President and Head, Corporate Banking, Kotak Mahindra Bank said, “the sustained pause in the repo rate hike is poised to benefit India’s economic trajectory positively. Moreover, the remarkable growth in capital expenditure witnessed in FY24, coupled with robust capex push by the government underscores a pivotal moment for economic resurgence. The capex push also aligns with the broader endeavour to propel India towards achieving its $5 trillion economy milestone.”
While stating that domestic economic activity is strengthening, the policy panel has projected a lower GDP growth of 7 per cent for financial year 2024-2025 (FY 2025), down from 7.3 per cent projected by the National Statistical Office (NSO) for FY24.
“Headwinds from geopolitical tensions, volatility in international financial markets and geoeconomic fragmentation pose risks to the outlook,” Das said. Taking all these factors into consideration, the MPC has projected real GDP growth for the first quarter (Q1) of 2024-25 at 7.2 per cent, Q2 at 6.8 per cent, Q3 at 7.0 per cent and Q4 at 6.9 per cent.
However, the government has projected nominal GDP growth higher — including the pace of inflation — of 10.5 per cent in the Interim Budget presented on February 1 as against 8.9 per cent in 2023-24. The high nominal growth helps the government bring down fiscal deficit.
Nominal GDP refers to the GDP evaluated at current market prices without excluding the pace of inflation. However, it can inflate the growth figure.
“Looking ahead, recovery in rabi sowing, sustained profitability in manufacturing and underlying resilience of services should support economic activity in 2024-25. Among the key drivers on demand side, household consumption is expected to improve, while prospects of fixed investment remain bright owing to upturn in the private capex cycle, improved business sentiments, healthy balance sheets of banks and corporates and the government’s continued thrust on capital expenditure,” the MPC said.
GDP growth in the second quarter of the current financial year has been significantly higher than market and RBI’s forecasts at 7.6 per cent, translating to a robust growth of 7.7 per cent in the first half of FY24. “We expect a moderation in growth in the second half of the year given the impact of El Nino on rainfall in the current year and its consequent effect on agricultural output and rural demand. Some of the high frequency indicators such as two-wheeler and FMCG sales as well as higher demand for MGNREGS reflect a weakness in rural incomes,” Suman Chowdhury, Chief Economist and Head, Research, Acuité Ratings & Research.
The RBI has retained the policy stance as the ‘withdrawal of accommodation’ despite the deficit in the liquidity in recent weeks. “Our stance of withdrawal of accommodation should be seen in the context of incomplete transmission and inflation ruling above the target of 4 per cent and our efforts to bring it back to the target on a durable basis,” Das said.
However, analysts said there is a strong case for the RBI to change its stance from “withdrawal of accommodation” to “neutral”. Financial condition has tightened a lot in the last few quarters. Real rates are reasonably high and likely to increase further as inflation is trending down. Liquidity condition has also tightened with banking system liquidity running in deficit of over Rs. 2 lakh crore on daily basis.
“Its impact is clearly visible in the money market with AAA-rated PSU banks issuing three-months CDs at more than120 bps above the repo rate. In the last five years, this spread has been close to 30-50 basis points,” said Pankaj Pathak, Fund Manager, Fixed Income, Quantum Asset Management.
The RBI is expected to maintain the system liquidity at a slightly deficit level to ensure better transmission of interest rates and this has been in evidence in November. “With higher govt. bond redemptions scheduled in the current month and also the likelihood of higher FPI flows, the RBI may consider the deployment of tools like OMO to suck up additional liquidity from the market,” said Chowdhury.
While retaining the retail inflation projection at 5.4 per cent for 2023-24, Das said, “uncertainty in food prices continues to impinge on headline inflation and MPC remains resolute on containing inflation at the target of 4 per cent.” In the December policy review also, the RBI projected the retail inflation at 5.4 per cent for 2023-24.
“Headline inflation has remained high and has seen considerable volatility, moving in a range of 4.3 per cent to 7.4 per cent during the current financial year. Recurring food price shocks could interrupt the ongoing disinflation process, with risks that it could lead to de-anchoring of inflation expectations and generalisation of price pressures,” Das said.
Retail inflation surged to a four-month high of 5.69 per cent in December driven by higher prices of food items such as pulses, spices, fruits and vegetables, data released by the NSO showed. The MPC’s primary focus is to bring down CPI inflation sustainably to around 4 per cent and this is unlikely to change. “The RBI will also keep an eye on rate differentials as it has an impact on the capital flows to India and the currency movements. Therefore, the timing and extent of US Federal Reserve rate cuts in the current calendar is also a key variable in the MPC decision,” said Suman Chowdhury, Chief Economist and Head, Research, Acuité Ratings & Research.
Food inflation will remain a key risk factor for headline inflation in India. With the continuing impact of El Nino on agricultural impact, there is an upside risk to food inflation which can keep the overall retail inflation near to 6 per cent over the next six months, Chowdhury said. However, analysts expect the government to take timely and proactive steps to prevent any further and sharp rise in food prices particularly before the elections.
