RBI Policy Review: Hikes by 50bps amidst a global storm

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The RBI policy announcement today came with no major surprises and was broadly in line with our expectations. The central bank raised the repo rate by 50bps, aligning itself with aggressive monetary policy action globally. The decision was consistent with elevated inflationary risks and domestic growth that continues to hold up.

Policy rate announcement: The RBI raised the policy rate to 5.90% and the SDF rate was accordingly raised to 5.65%. The policy rate announcement was not unanimous, with MPC member Ashima Goyal voting for a 35bps rate hike. On stance, all members voted for an unchanged stance, except for MPC member Jayant Verma who dissented.

Inflation and Growth: The RBI kept its inflation forecast unchanged at 6.7% for FY23, sounding cautious about the uncertainty around inflationary pressures, despite the recent moderation in global crude oil, stemming from higher food inflation and continued pressure on services inflation. On growth, the RBI revised down its GDP forecast by 20bps to 7% for FY23 — largely reflecting the lower-than-expected Q1 GDP numbers. The commentary on growth remained upbeat as the RBI highlighted the continued improvement in domestic fundamentals while recognizing that there are global headwinds that could present downside risks going forward.

Stance: The central bank did little to remove the ambiguity and perceived deviation around its stance, keeping it unchanged at “withdrawal of accommodation”, contrary to our expectations that a move to neutral was on the cards. The RBI justified its stance by emphasizing that liquidity conditions remain in surplus mode and that the nominal policy rate continues to trail inflation. This contrasts with 2019 – when the stance was last neutral –liquidity was in deficit and the policy rate was higher than inflation leading to positive real rates in the economy. However, in the post-policy press conference, Governor Das abstained from committing to a definitive marker (or any forward guidance) either in the form of the liquidity level, the operating rate, or the level of real interest rate that would trigger a change in stance at this stage.

Liquidity: The central bank said that it will continue to undertake two-way operations to manage liquidity conditions. With moderation in liquidity surplus, the RBI has decided to merge the 28-day VRR auctions with the fortnightly 14-day main auction. Going forward, from now on only 14-day VRRR auctions will be conducted. In the post-policy press conference, Governor Das re-iterated that the central bank would continue to keep liquidity conditions comfortable and as the impact of advance tax flows fades, there is drawn down excess SLR and CRR by banks, and government spending increases, liquidity conditions are likely to improve. System liquidity surplus stood at INR 0.68 lakh cr as of 29th September 2022 (as compared to INR 2 lakh crore in August 2022 end). We expect average liquidity in the system to remain in surplus in Q3, supported by RBI’s fine-tuning operations. That said, the level of systemic liquidity as seen by the balances under the LAF window is likely to average lower than what has been recorded in Q2 FY23 (average: INR 2.16 lakh crore in Q2).

External resilience and the rupee: The central bank re-iterated the resilience of India’s external balances compared to our peers in today’s policy announcement. On the rupee, as we have argued before, the RBI emphasized that their strategy would be focused on maintaining investor confidence and anchoring expectations — signaling that FX interventions are likely to continue and be focused on defending any extreme volatility in the rupee. The absence of any additional measures in order to shore up reserves and attract capital (like was done in 2013) signals RBI’s comfort with the current level of foreign exchange reserves as well as the level of the rupee. Given the continued dollar rally and elevated global risks, the USD/INR pair is likely to witness continued depreciation pressures and we expect a range of 81-82 in the near term. In extreme risk-off, we continue to expect the central bank to provide support and curtail the quantum of fall in the currency.

Policy outlook: The central bank refrained from providing forward guidance on terminal rates and kept the window open for the quantum and pace of rate action in response to the evolving global and domestic conditions. We expect the RBI to continue with its rate hikes in the upcoming policies taking rates up to 6.5% (terminal rate) by the end of the fiscal year.

Bond yields & FX update: The 10-year yield was largely flattish at 7.343% (post the policy announcement) vs. yesterday’s closing level of 7.34% as the policy was on expected lines. The 10-year yield is trading at 7.355% at the time of writing. We expect the 10-year paper to trade closer to 7.3-7.4% by the end of the quarter. On the FX front, the USD/INR strengthened post the policy announcement to 81.55 vs. yesterday’s closing level of 81.86.

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