 "Monetary policy review: RBI holds rates steady as inflation looms large")
The Reserve Bank of India (RBI) on Thursday kept the repo rate unchanged at 6.5 per cent for the third straight policy review while ignoring the expected spike in July retail inflation even if it tightened liquidity conditions, albeit temporarily.
The six-member Monetary Policy Committee (MPC) unanimously held the repo rate. Except Jayanth Varma, all members voted to maintain the stance “withdrawal of accommodation”. Though the decision on the rates and the stance was expected, the central bank brought in a surprising element by mandating all scheduled commercial banks maintain an incremental cash reserve ratio (I-CRR) of 10 per cent on the increase in their net demand and time liabilities (NDTL) between May 19, 2023, and July 28, 2023, with effect from August 12.
“With respect to incremental CRR, this was considered necessary in the background of a liquidity overhang,” RBI Governor Shaktikanta Das said.
Banks parked over Rs. 2 trillion with the RBI’s liquidity adjustment facility in August. The withdrawal of Rs. 2,000 notes announced in May — 90 per cent of which have come back so far — was one of the main reasons for the liquidity overhang, apart from government spending.
“It is a temporary measure and will be reviewed on September 8 or earlier. We will ensure there is adequate liquidity in the system to maintain the credit needs of the economy,” Das said, adding the central bank was sensitive to cash requirements ahead of the festival season, which will start in late September/early October.
The incremental NDTL of all scheduled commercial banks during the May 19-July 28 period was around Rs. 10 trillion. Banks have to maintain an additional CRR of 10 per cent, or around Rs. 1 trillion, from the fortnight beginning August 12, a report from State Bank of India said, adding that absorption amounted to 0.3 per cent of the current NDTL of scheduled commercial banks.
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“With the current move of incremental CRR of 10 per cent, surplus liquidity will come down to Rs. 2.6 trillion,” said Soumya Kanti Ghosh, group chief economic adviser, State Bank of India.
The incremental CRR decision is not likely to have any impact on the bond market because it is temporary but can impact the short-term yield of the 91-day treasury bill. The weighted average call rate was 6.45 per cent on Thursday, as compared to 6.39 per cent on Wednesday. Dealers said overnight rates were also likely to go beyond the repo rate due to the CRR move.
The consumer price index-based (CPI-based) inflation rate, which was below 6 per cent in April, May, and June, is expected to rise above the upper tolerance limit of the central bank again in July because of increasing vegetable prices.
The MPC, however, was of the view that prices would come down soon, and should be ignored even if the inflation projection for the second and third quarters was sharply increased. As a result, the average inflation forecast for FY24 was revised to 5.4 per cent as compared to 5.1 per cent projected during the June policy.
“Monetary policy has made significant progress towards price stability; the recent spike in CPI inflation is expected to be short-lived, going by past trends. In such a situation we need to remain watchful and not resort to any knee-jerk reaction,” Das said.
“The RBI raised its average CPI inflation forecast for FY24 to 5.4 per cent Y-o-Y on the back of a 100 basis point increase in its Q2FY24 forecast to 6.2 per cent and a 30 basis point increase in its Q3FY24 forecast to 5.7 per cent. Governor Das noted that vegetable prices may significantly correct going forward, going by historical trends,” Goldman Sachs said in a report.
Growth projection for FY24 was retained at 6.5 per cent as the RBI is of the view that aggregate demand conditions continue to be buoyant.
Das said among urban demand indicators, domestic air passenger traffic, passenger vehicle sales, and household credit were exhibiting sustained growth. In the case of rural demand, tractor and fertiliser sales improved in June while two-wheeler sales moderated.
“Looking ahead, these underlying developments and the upcoming festival season are expected to provide support to private consumption and investment activity,” Das added.