Why RBI has opted for status quo, how continued pause in rate hikes affects your loan EMIs

Why is the RBI in pause mode on raising interest rates?

The pause in the Repo rate — the rate at which RBI lends money to banks to meet their short-term funding needs — on Thursday (June 8) is for the second time since the RBI started hiking Repo rate in May 2022 to check inflation. In the April policy, the MPC members, in a surprise move, had unanimously decided to pause the rate hike cycle.

Since the April policy, consumer price index-based inflation (CPI), or retail inflation, has eased further. It declined to an 18-month low of 4.7 per cent in April from 5.7 per cent in March, remaining under the RBI’s comfort zone of 2-6 per cent for two consecutive months. The RBI is mandated to keep CPI at 4 per cent with a band of +/- 2 per cent.

Also, India’s gross domestic product (GDP) expanded at 6.1 per cent January-March 2023 quarter, in turn pushing up the growth estimate for the full year (2022-23) to 7.2 per cent. With ease in inflation and strong GDP growth, the RBI is likely to maintain the status quo in the June policy, experts said.

“Headline inflation is above the targeted level (four per cent)… and likely to remain above that level in FY24,” Governor Das said on Thursday.

Analysts said trends for May suggest inflation could ease closer to 4 per cent year-on-year, helped by base effects, as core and non-core segments soften. As a result, the average Apr-Jun 2023 inflation is expected to undershoot the RBI’s forecast by 50-60 bps (basis points). The softening inflation and robust recovery have prompted the MPC to opt for a pause, said an analyst.

“In the past two months, retail inflation has been below the RBI’s tolerance limit, which gives comfort to the RBI to keep repo rate and stance unchanged,” said Manish Jain, Fund Manager, Coffee Can PMS, Ambit Asset Management.

The RBI’s decision to leave the repo rate unchanged also factored in the possible pause by the US Federal Reserve in its meeting scheduled later this month. However, two major central banks had recently hiked rates after a pause.

“Mixed signals from the US (labour market, manufacturing activity), has raised the probability (70 per cent) of Fed entering wait and watch mode by opting for a pause in June 2023,” Bank of Baroda said in a note.

What will happen to lending and deposit rates?

As the RBI has kept the policy rate unchanged in the June policy, external benchmark lending rates (EBLR) linked to the repo rate will also not rise. It will provide some relief to borrowers as their equated monthly instalments (EMIs) will not increase.

Notably, EBLRs — 81 per cent of which 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, DBS Group said.

Banks will also not increase fixed deposit rates. 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 should not be seen as a flattening of the rate hike cycle. The RBI in its statement said that it remained focused on the withdrawal of accommodative stance.

“Given continued turbulence internationally and possible slowdown due to happenings in banking space in developed countries one expects the current cycle to continue. This means the credit cost for retail and institutional borrowers is expected to remain high and this should be factored in their budgetary planning for FY2023-24,” said Kalpesh Dave, Head – Corporate Planning & Strategy, Star Housing Finance Ltd.

Existing and new home buyers should expect relatively higher outgo in their monthly instalments. However, borrowers can continue to look at 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 means reducing the money supply in the system which will rein in inflation further.

“The RBI will continue with the withdrawal of accommodation till they are assured that the El Nino impact and the food risk (to inflation) is over, and then they will switch to neutral,” said Abheek Barua, Chief Economist, HDFC Bank.

The liquidity condition in the banking system has improved because of the deposit of Rs 2000 banknotes which were withdrawn from circulation last month and higher government spending. On June 6, the net liquidity surplus in the banking system stood at Rs 2.11 lakh crore, RBI data showed.

According to Bank of Baroda economist Sonal Badhan, due to withdrawal of Rs 2000 note, the RBI’s need to infuse durable liquidity for the time being has reduced.

What is the outlook on GDP and inflation?

On Thursday, the policy panel said the retail inflation is expected to be just above 5 per cent at 5.1 cent, down from the 5.2 per cent estimated earlier, and kept the real GDP growth projection unchanged at 6.5 per cent in FY24.

The fall in retail inflation was largely on account of a favourable base. “CPI food index also moderated on the same account. Current dip in international oil prices, food prices and other commodity prices, we expect inflation to remain within RBI’s targeted band in coming months. Persistent favourable base will also help,” Bank of Baroda said in a report.

However, upside risks do persist. Delayed onset of the monsoon, voluntary production cuts announced by OPEC members to support crude oil prices, and passing of the debt ceiling deal in the US might exert upward pressure on commodity and domestic food prices, BoB said.