RBI policy: Why Monetary Policy Committee is likely to maintain repo rate pause

The six-member rate-setting panel will meet against a backdrop of growing domestic as well as external economic challenges. These domestic challenges encompass growing risks to consumption demand amid soaring 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 the credit policy will most likely continue with the existing rate structure and policy stance. The repo rate, the rate at which the RBI lends money to banks to meet their short-term funding needs, currently stands at 6.5 per cent.

“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 the potential to push up prices further,” Sabnavis said.

Last month, 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. The RBI will remain watchful of this situation, he had said.

Consumer price index (CPI) based inflation, or 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. We, therefore, expect the MPC to maintain a hawkish pause,” said Upasna Bhardwaj, Chief Economist, Kotak Mahindra Bank.

Since the August 10 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 recent Bank of Baroda report said.

“The recent spike in crude oil prices and global bond yields shall keep MPC vigilant on inflation-growth dynamics. The MPC is expected to maintain status quo on rates and stance at the upcoming October meeting,” said Parijat Agrawal, head, fixed income, Union Asset Management Company.

Will there be a change in GDP growth forecast?

The RBI is unlikely to change its GDP forecast in the upcoming monetary policy, economists said.

“With the prevailing economic headwinds, we expect the RBI to retain its growth projections at 6.5 per cent for FY24 as the RBI will likely adopt a ‘wait and watch’ approach, seeking better visibility on festive demand trends and estimates of kharif production before making any adjustments,” Care Ratings said in the report.

The growth fundamentals still remain strong but the key uncertainty remains around the impact of a weak monsoon on agriculture production, the BoB report said. It expects GDP growth to moderate to around 6.3 per cent in FY2024, slightly lower than the RBI’s projection of 6.5 per cent. The lower estimate is based on the expectation of continued slowdown in Europe and China, weaker exports, and risks to rural demand on the back of weak monsoon activity this year, BoB’s economist Sonal Badhan said in the report.

Can inflation projection be revised?

Analysts expect revision in inflation projections for the second quarter and for FY2024 but not in a significant manner.

While the volatile component of the food basket has cooled significantly, price pressures persist in cereals, spices, and pulses, Care Ratings said.

The sowing of pulses has lagged by approximately 4.6 per cent in this kharif season, and high-frequency retail prices suggest a sequential uptick in the prices of pulses in September.

However, the rating agency expects food inflation to moderate going ahead, with average inflation in the food basket slowing from 6.9 per cent in Q2 to 5.6 per cent in Q3 and 5.1 per cent in Q4 of FY2024.

Despite the steep rise in global crude oil prices, it is anticipated that this will not significantly impact retail inflation, as there will be pressure on oil marketing companies (OMCs) to refrain from increasing retail prices for petrol and diesel, it said.

“A 10 per cent increase in oil prices can push up CPI inflation by about 30 bps (basis points), but it is unlikely for retail pump prices to go up in the coming months, given bunched up state elections in October-December 2023 and general elections in April/May 2024,” said Kaushik Das, Chief Economist, India & South Asia, Deutsche Bank, in a recent report.

This looks more plausible, given that the central government has recently cut prices of LPG by INR200/cylinder, which is expected to soften CPI inflation by 20-25bps, he said.

The RBI is also likely to find comfort in the fact that the wholesale price index (WPI) continues to remain in deflationary territory, and core inflation remains relatively benign. In August, core inflation moderated to 4.9 per cent, down from 5.1 per cent in July, Care Ratings said.

“We expect the September inflation print to remain above the RBI’s upper tolerance limit. As a result, the RBI will miss its Q2 inflation projections by around 60 bps and will consequently revise its whole-year projection to 5.6 per cent from an earlier projection of 5.4 per cent,” the rating agency said.

In its August monetary policy, the RBI had revised upwards its FY2024 CPI projection to 5.4 per cent from an estimate of 5.1 per cent announced in June. The CPI print in Q2 was projected at 6.5 per cent.

Will any liquidity measure be announced?

According to Sabnavis, the RBI is unlikely to announce any specific liquidity measures as it is tight today and the RBI is in the process of rolling back the incremental cash reserve ratio (I-CRR) which was invoked in the August policy.

Liquidity conditions in the banking system have undergone a significant tightening since the August policy meeting. Systemic liquidity, which had been in surplus at Rs 2.1 lakh crore during the August MPC meeting, transitioned into a deficit of Rs 1.5 lakh crore by September 27.

This shift has increased money market rates, with the overnight call money rate rising from 6.4 per cent to 6.8 per cent, Care Ratings said. The RBI implemented I-CRR in the last MPC meeting, resulting in the withdrawal of liquidity amounting to Rs 1.1 lakh crore from the banking system.

Despite the gradual withdrawal of the I-CRR, systemic liquidity continued to stay in the deficit since mid-September due to quarterly tax outflows and GST payments, it said.

Additionally, interventions in the foreign exchange market aimed at supporting the rupee may have marginally contributed to some absorption of rupee liquidity.

Care Ratings said despite positive news on FAR (Fully Accessible Route) bond inclusion in international indices, the 10-year benchmark government security (G-Sec) yield continues to harden. The positive news of index inclusion was overshadowed by concerns about higher international crude prices, elevated headline inflation prints, and hawkish commentary from officials of Western central banks. The 10-year G-sec benchmark yield stands at 7.24 per cent, higher than 7.17 per cent at the start of the month.

“Going ahead, RBI may conduct liquidity management operations as and when required to support the money market conditions. Having said that, we expect the overall liquidity situation to remain tight,” Care Ratings said.