RBI plays out familiar script, more rate hikes to follow

In 2019, when retail inflation was 3%, the policy rate was 5.75%. Now inflation hovers around 7% and the policy rate is 5.9%. It needs to move up

Yet again, the Reserve Bank of India (RBI) has raised the policy rate by 50 basis points (bps) to 5.9 per cent, pared the growth projection for FY2023 from 7.2 per cent to 7 per cent, and left the inflation estimate for the year unchanged in its latest monetary policy. One bps is a hundredth of a percentage point.

The stance of the policy continues to be “withdrawal of accommodation, while supporting growth”.

Everything is on expected lines. Both bond and equity markets cheered RBI Governor Shaktikanta Das’s no-surprise policy. This is how a stock broker sums it up: After a horror movie by the US Fed and a tragicomedy by the Bank of England, India’s central bank has released a pure romance on Friday! Taking the film imagery further, a fund manager describes it as Das’s Main Hoon Na policy (referring to a 2004 Shah Rukh Khan-starrer Hindi film, directed by Farah Khan).

At the post-monetary policy interaction with the media, Das disowned the word “frontloading” (of rate hikes) and stuck to the familiar script of a “calibrated” approach, driven by incoming data. (“Some MPC [Monetary Policy Committee, the RBI’s rate-setting body] members have used that, not me,” he clarified.) Keeping inflation in check and nurturing growth while protecting macroeconomic stability will remain the objective of the policy.

He also said that the Indian central bank’s decision on policy rate would be driven by domestic considerations and not what other central banks have been doing.

I would expect another rate hike in December — probably 35 bps. There could be even an encore in February 2023 to take the policy rate to 6.5 per cent before the financial year ends.

Why am I saying so?

Take a close look at this part of the governor’s statement:

“Monetary policy had moved from neutral to accommodative stance in June 2019. At that time, the repo rate was 5.75 per cent; headline CPI inflation was hovering around 3 per cent and was expected to be in the range of 3.4 to 3.7 per cent in H2:2019-20…

“Today, inflation is hovering around 7 per cent and we expect it to remain elevated at around 6 per cent in H2:2022-23...

“Thus, even as the nominal policy repo rate has been raised by 190 basis points so far (including today’s increase), the policy rate adjusted for inflation trails the 2019 levels.” (Italics mine.)

Without being explicit, Das is referring to the negative real rate. When retail inflation was 3 per cent and expected to rise to 3-4-3.7 per cent, the policy rate was 5.75 per cent. Now when inflation hovers around 7 per cent and is expected to be over 6 per cent in the second half of the year, the policy rate is 5.9 per cent. It needs to move up. It’s elementary, my dear Watson.

The policy statement has clarified quite a few things regarding inflation, liquidity, and foreign exchange reserves.

In the first half of FY23, the Indian basket crude oil price was around $104 a barrel. Assuming it to be $100 per barrel in the second half, the inflation projection is retained at 6.7 per cent in 2022-23, with 7.1 per cent in the second quarter, 6.5 per cent in the third, and 5.8 per cent in the fourth quarter, with “risks evenly balanced”. Inflation is projected to go down further to 5 per cent in the first quarter of 2024.

Consumer price inflation was 7 per cent in August, remaining above the upper tolerance band of the RBI’s flexible inflation target (4 per cent +/- 2 per cent) for eight months in a row. It will rise further in September. Under the law, if inflation remains above the higher band for nine successive months, the RBI owes an explanation to the government. The recent correction in global commodity prices, including of crude oil, if sustained, may ease cost pressures in the coming months, the statement says.

The RBI has not given much credence to the noise on lack of liquidity in the banking system. Indeed, the surplus liquidity has come down to Rs 2.3 trillion during August-September 2022 (up to September 28) from Rs 3.8 trillion during June-July but this is temporary, Das has pointed out, assuming that government spending will pick up in the second half of the year.

Moreover, the banking system has excess cash reserve ratio (the portion of deposits that commercial banks keep with the central bank on which they don’t earn any interest, currently at 4.5 per cent) and excess statutory liquidity ratio (the government bonds in banks’ portfolio), which they can liquidate to generate money. He has assured the market that the RBI would continue to fine-tune its instruments for absorption as well as injection of liquidity as may be necessary from time to time. To start with, it has abolished the 28-day variable rate reverse repo or V-RRR auctions and stuck to 14-day V-RRR.

The RBI absorbs banks’ excess liquidity through its reverse repo window. A part of it is done at a fixed rate and the rest at a variable rate.

The RBI is also unfazed over the more than $100-billion drop in India’s foreign exchange reserves in the past one year. About 67 per cent of the decline in reserves during the current financial year is due to “valuation changes arising from an appreciating US dollar and higher US bond yields”.

This means that apart from depreciation in other currencies in the RBI’s forex basket vis-à-vis the greenback, rise in bond yield in the US has dented the pile of foreign exchange reserves. Bond yields and prices move in opposite directions. The prices at which the RBI had bought the bonds have come down with the rise in yield, and the Indian central bank has to make good the losses.

Pointing to the fact that India’s external debt to GDP ratio is the lowest among major emerging market economies, Das exudes confidence in meeting external financing requirements comfortably.

With the rise in policy rate, there will be another round of loan rate hikes by commercial banks. The borrower will have to pay more. As of December 2021, a little over 39 per cent of the banking industry’s loans were linked to external benchmark-based lending rate (EBLR), introduced in December 2019. Since then, it has risen further. All loans given to the micro, small and medium enterprises as well as retail loans are linked to EBLR. Banks primarily use the repo rate and, for some products, the 364-day T Bill rate, as an external benchmark.

The deposit rates will also go up. In June 2019, when inflation was 3 per cent and policy rate 5.75 per cent, India’s largest lender State Bank of India’s savings bank account rate was 3.5 per cent up to Rs 1 lakh and 3.25 per cent above Rs 1 lakh. Now, when inflation is 7 per cent and policy rate 5.9 per cent, its savings bank account rate is 2.7 per cent. Similarly, it had offered 7 per cent for fixed deposits maturing in less than two years (up to Rs 2 crore) in June 2019. Now the rate is 5.45 per cent. Banks have no choice but to raise deposit rates if they want to sustain credit growth.

The writer, a consulting editor with Business Standard, is an author and senior adviser to Jana Small Finance Bank Ltd

His latest book: Pandemonium: The Great Indian Banking Tragedy

To read his previous columns, log on to https://bankerstrust.in

Twitter: @TamalBandyo