Interest rates in the Indian financial system will remain unchanged following the decision of the Monetary Policy Committee (MPC) of the Reserve Bank of India (RBI) to keep the main policy instrument – the Repo rate – unchanged at 6.50 per cent Thursday. Equated monthly instalments (EMIs) of home, vehicle and other loans are expected to remain steady for the time being.
While the six-member MPC, led by RBI Governor Shaktikanta Das, has retained the policy stance as ‘withdrawal of accommodation’, it has hiked the inflation projection from 5.1 per cent to 5.4 per cent for FY2024 in the wake of the high food inflation, signalling that a rate cut is unlikely in the near future.
Why is the RBI in pause mode?
The pause in the Repo rate – the rate at which RBI lends money to banks to meet their short-term funding needs – on Thursday (August 10) is for the third time since the RBI started hiking the Repo rate in May 2022 to check inflation.
In April policy, the MPC members, in a surprise move, had unanimously decided to pause the rate hike cycle. Monetary policy transmission is still underway after the RBI slashed the Repo rate by 250 basis points since May 2022 and headline inflation is expected to remain above the five per cent level and even touch even 6.2 per cent in the second quarter of this year.
While the vegetable price shock may reverse quickly, possible El Nino weather conditions along with global food prices need to be watched closely against the backdrop of a skewed southwest monsoon so far, RBI Governor Shaktikanta Das said.
Why RBI has hiked inflation projection and its impact
While keeping the GDP growth unchanged at 6.5 per cent, the RBI has hiked the inflation projections to 5.4 per cent for 2023-24 and above five per cent till the first quarter of 2024-25. The benchmark Sensex fell by over 400 points in intra-day trade amid worries that a rate cut is likely to be delayed due to the high inflation projection.
On Thursday, the RBI revised its FY2024 inflation projection to 5.4 per cent from 5.1 per cent announced in June. It said CPI inflation is expected to be at 6.2 per cent in the second quarter, 5.7 per cent in the third quarter and 5.2 per cent in the fourth quarter of FY2023-24. “This means the high policy rates will remain high for long and, therefore, a rate cut can be expected only in Q1 FY25,” said VK Vijayakumar,” said Chief Investment Strategist at Geojit Financial Services.
Das said the spike in tomato prices and the rise in cereal and pulses contributed to inflation. However, vegetable prices may see a significant correction, he said. “Going by the past trends, vegetable prices may see a significant correction after a few months. The prospects of kharif crops have brightened, thanks to improvement in the progress of the monsoon. Uncertainties, however, remain on domestic food price outlook due to sudden weather events and possible El Niño conditions in August and beyond,” Das said.
Retail inflation (measured using the consumer prices index or CPI) had declined to an 18-month low of 4.3 per cent in May from 5.7 per cent in March, remaining under the RBI’s comfort zone of 2-6 per cent for two consecutive months. However, inflation has picked up since then and it’s likely to rise in the range of 6-6.8 per cent in July from 4.81 per cent in June. The RBI is mandated to keep CPI at 4 per cent with a band of +/- 2 per cent.
What will happen to lending, deposit rates?
As the RBI has kept the policy rate unchanged in the August policy, all external benchmark lending rates (EBLR) linked to the repo rate will not rise. It will provide some relief to borrowers as their equated monthly instalments (EMIs) will not increase. Notably, EBLRs – 81 per cent of are linked to the benchmark repo rate – now dominate the mix of outstanding floating rate loans, with the share rising to 48.3 per cent by December 2022, whilst those based on MCLR (marginal cost of fund-based lending rate) eased to 46 per cent.
Banks will also not increase fixed deposit rates in case of a pause. The decision to hold deposit rates at the current levels will be driven by surplus liquidity in the banking system due to improvement in low-cost current account and savings account (CASA) balance following the deposit of Rs 2000 banknotes.
The pause in the Repo rate hike taken by the RBI, if at all provides a breather, should not be seen as a flattening of the rate hike cycle as the RBI in its statement has said that it remains focused on the withdrawal of accommodative stance.
Existing and new home buyers should brace for continued relatively higher outgo in the form of their monthly instalments. However, borrowers can continue to look for options to refinance their existing debt obligations and even evaluate fixed-rate loans if the cost-benefit dynamics, in the long run, turn out to be positive for them.
Why has RBI retained the stance of withdrawal of accommodation?
The RBI has focused on its stance of ‘withdrawal of accommodation’ until all risks to inflation dissipate. An accommodative stance means the central bank is prepared to expand the money supply to boost economic growth. Withdrawal of accommodation will mean reducing the money supply in the system which will rein in inflation further.
What the RBI Governor said
RBI Governor said the upcoming festival season is expected to provide support to private consumption and investment activities. FMCG sales pick up in rural areas reflecting the incipient revival of rural demand. It is expected to get a further boost with a good Kharif harvest, he said.
Looking ahead, the recovery in kharif sowing and rural incomes, the buoyancy in services and consumer optimism should support household consumption. Healthy balance sheets of banks and corporates, supply chain normalisation, business optimism and robust government capital expenditure are favourable for a renewal of the capex cycle which is showing signs of getting broad-based, said the Governor.
While the six-member MPC, led by RBI Governor Shaktikanta Das, has retained the policy stance as ‘withdrawal of accommodation’, it has hiked the inflation projection. (REUTERS/Danish Siddiqui/File Photo) 
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