RBI’s status quo and an indication that rate cuts would have to wait: What’s in store for borrowers, depositors

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 Friday (October 6) is for the fourth time since the RBI started hiking 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 incomplete 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.

RBI Governor Shaktikanta Das said the overall inflation outlook is clouded by uncertainty by the fall in kharif sowing, lower reservoir levels, volatile global food and energy prices. Further, recurring incidents of large food price shocks can impart generalisation and persistence to headline inflation.

What will happen to lending, deposit rates?

As the RBI has kept the policy rate unchanged in the October 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 the wake of the pause in Repo rate. 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 rate hike cycle as the RBI in its statement has said that it remains focused on the withdrawal of the 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. After the RBI withdrew Rs 2,000 notes from circulation, of the total value of Rs 3.56 lakh crore banknotes in circulation as of May 19, 2023, Rs 3.42 lakh crore has been received by the banking system.

Das also indicated more OMOs (open market operations) to manage liquidity in the system.

What are the risks ahead?

“We have identified high inflation as a major risk to macroeconomic stability and sustainable growth,” Das said on Friday. The six-member rate-setting panel met against a backdrop of growing domestic as well as external economic challenges. These domestic challenges encompass growing risks to consumption demand amid high food inflation, an uneven monsoon adversely affecting kharif crops, higher interest rates and rising global crude oil prices, a Care Ratings report said.

Bank of Baroda Chief Economist Madan Sabnavis said, “inflation is still high at 6.8 per cent and while we do expect it to come down sharply in September and October, there is still some pessimism on Kharif output especially relating to pulses which has potential to push up prices further.” RBI Governor Shaktikanta Das said the frequent incidences of recurring food price shocks pose a risk to anchoring of inflation expectations, which has been underway since September 2022.

Retail inflation eased to 6.83 per cent in August from a 15-month high of 7.44 per cent in July. It continues to remain above the RBI’s comfort zone of 2-6 per cent. “Food inflation risks along with rising crude oil prices remain a concern,” said Upasna Bhardwaj, Chief Economist, Kotak Mahindra Bank.

Since the August 10th policy, international crude oil prices have averaged nearly $89 per barrel, sitting above $85 per barrel factored into RBI estimates (April 2023 policy briefing). In fact, since September 8, prices have hovered above $90 per barrel. At the time of the last RBI policy, oil prices averaged around $79 per barrel, implying a 12.6 per cent jump in prices since the previous policy, a Bank of Baroda’s recent report said. The recent spike in crude oil prices and global bond yields will keep MPC vigilant on inflation-growth dynamics.