The monetary policy committee decided to keep the policy repo rate unchanged without committing to a pivot. Thus, the current pause still signals a tightening stance as projected inflation continues to be above the tolerance band of RBI. From this perspective current policy remains a non-event, largely on expected lines.
The outlook on global economy is clouded by sideways movements in most of the indicators even when moderating inflation, tighter financial conditions, banking sector stress, and lingering geopolitical conflicts persist. Weak external demand owing to slowdown in advanced economies, elevated debt levels and geoeconomics disintegration amidst tighter external financial conditions pose risks to growth prospects.
Domestic GDP growth is now on firm footing with urban demand showing good traction. The lagging rural demand is a cause of concern and high frequency indicators show movements both ways, preventing a concrete opinion formation. The RBI GDP forecast for FY24 has undergone some change since April policy in light of CSO estimate for FY23 GDP. Upward revisions have happened in H1 while marginal downward revisions have been made in H2. It is interesting to note that list of positive factors influencing growth as stated in RBI policy statement outweighs negative factors in the same.
Importantly, the series of RBI rate hikes have resulted in a combination of declining unemployment rate and stabilizing vacancy rate over the period of RBI rate hike cycle. This signifies that RBI’s rate hikes have been able to successfully trim the excess labor demand in the market without contraction in employment. Additionally, the declining current inflation as well as declining inflation expectations for next fiscal gives a clear-cut signal that there is no conflict in the inflation and its expectations, signifying that the lagged impact of rate hikes will be able to successfully control inflation in the target band.
Inflation has cooled substantially in May on the back of large favourable base effects and witnessed notable corrections across groups. The inflation trajectory is now conditional on spatial variation of monsoons and possible development to ENSO. The headline inflation trajectory is likely to be shaped by food price dynamics. Wheat prices could see some correction on robust mandi arrivals and procurement under the shadow of possible sharp drop in output in Australia. The inflation glidepath of RBI for FY24 has undergone some revision with FY24 inflation expected to peak in Q3.
Meanwhile, liquidity surplus in the system has again increased with the Net LAF absorption at Rs 2.2 lakh crore as on 07 June from an average of Rs 1.0 lakh crore in Apr-May’23. The government surplus cash balances has also started declining from the 3rd week of May. Even the deposit of Rs 2000 notes in banks has added to the liquidity. As we have earlier highlighted, around 85% of the Rs 2000 notes are deposited in the bank accounts and not exchanged for smaller denominations. Thus, bank deposits are likely to increase by atleast Rs 2 lakh crore assuming some of the notes would already be with banks in currency chests. Overall deposit growth in FY24 should grow over 11% yoy. This will effectively imply that spate of deposit rate hikes could be a thing of the past.
The regulatory changes announced in the policy statement are positive.
With the increased popularity and acceptance of RuPay cards outside India, RBI has now permitted banks to issue RuPay Prepaid Forex cards to the Indians travelling abroad and also allowed RuPay cards to be issued in foreign jurisdictions.
Widening the scope of prudential framework for stressed assets will also further strengthen the recovery mechanisms.
The RBI decision to put in place a regulatory framework for permitting Default Loss Guarantee arrangements in Digital Lending is a win-win situation for loan service providers as well as for regulated entities (Banks/NBFC).
Overall, the RBI policy statement is cautious and pragmatic and is clearly aimed at managing expectation build-up of a rate cut not any time soon. The emphasis on 4% is to clearly anchor the market expectations for the future. While SBI Research rules out a rate cut any time soon, it must be reiterated that rate cuts in the past have happened over the cycle. For example, as growth weakened from 8% in FY16 to 6.8% in FY18, RBI had cut rates by 200 basis points. With GDP growth declining from 9.1% in FY22 to 6.5% in FY24, will this be construed as a signal of growth slowdown and hence future rate actions by RBI?
With GDP growth in FY24 set to decline from 8.0% in Q1 to 5.7% in Q4, SBI Research expects the first rate cut by RBI in Q4 FY24. The magnitude could be larger than 25 bps.
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