RBI Monetary Policy shifts gears, plans liquidity normalisation in near term

The Monetary Policy Committee of the Reserve Bank on April 8 kept the key interest rates unchanged and retained its accommodative stance but it made a slight shift on the liquidity front.

Drifting from its strictly dovish stand, it indicated a bit of hawkishness in its decision on gradual, calibrated withdrawal of liquidity over a multi-year time frame in a non-disruptive way. The regulator stayed firm on its stand to support growth while tackling inflation as a top priority for the time.

"This is clearly a hawkish policy as compared to the February meeting, justified by the inflationary pressures that have emerged over the past month," said Abheek Barua, Chief Economist, HDFC Bank.

The decision to maintain the status quo on key interest rates was on expected lines as an experts’ poll conducted by CNBC-TV18 revealed that 90 percent respondents expected the central bank to leave the rates untouched. Only 10 percent had hoped for a 25 bps hike in repo rates. To be sure, this was the eleventh meeting in a row that the committee did not change the key rates.

Spike in crude oil since February-end poses substantial risk to inflation. The projection of inflation is fraught with risk and contingent to global crude prices. Consequently, inflation is now projected to be higher and growth lower than February’s expectations.

"As the facts change, the RBI has accordingly shifted its assessment and this remains the key takeaway from the policy review" said Rajeev Radhakrishnan, CIO-Fixed Income, SBI Mutual Fund.

The RBI lowered its projected GDP growth for FY23 to 7.2 percent from 7.8 percent estimated in the last meeting. Assuming oil at $100, the GDP growth is seen at 6.2 percent in April-June, 6.2 percent in July-September, 4.1 percent in October-December, and at 4 percent in January-March quarters.

The MPC projected the CPI inflation higher at 5.7 percent for FY23, compared to 4.5 percent earlier. It is seen averaging 6.3 percent in April-June quarter, 5 percent in July-September, 5.4 percent in October-December, and 5.1 percent in January-March quarter.

"The April review was decidedly more nuanced and cautious in the assessment and guidance with the RBI acknowledging upside risks on inflation and taking measured steps to exit from the extremely accommodative policy stance," Radhakrishnan said.

This also implies that growth and inflation can be better if crude declines sharply if the war hopefully ends early. The reverse can also be true if the war aggravates and crude spikes much above $100.

The standing deposit facility (SDF) at 3.75 percent will now effectively serve as the floor for the liquidity adjustment facility (LAF) corridor. With marginal standing facility (MSF) rate at 4.25 percent, the LAF corridor has been restored to 50 bps.

By announcing the introduction of the SDF at 3.75 percent, the RBI has effectively delivered a stealth normalisation of the entire policy corridor, by linking it to the LAF corridor being normalised, instead of acting through the reverse repo rate.

"To us, this step effectively rolls back the accommodation the RBI provided via the corridor and liquidity provisions through the pandemic. We think this also implies that the RBI is now moving towards a new period of policy management, where the emphasis on supporting growth is reducing, and managing financial conditions more pro-actively rising," said Rahul Bajoria, MD and Chief India Economist, Barclays.

The governor pointed out that normalisation of LAF corridor done today should not come as a surprise to market participants. According to him, the financial markets were prepared for the LAF corridor over past several months.

"In our opinion, these announcements indicate the impending rise in repo rate over the next one-two policy meetings and may start to get reflected in a hike in banks' deposit rates in the near term," said Suman Chowdhury, Chief Analytical Officer, Acuité Ratings & Research.

The RBI enhanced hold to maturity (HTM) limit by 100 bps to facilitate the absorption of the increased bond supply, which could calm the bond markets despite a sharp increase in inflation forecast.

However, Barua from HDFC Bank believes that despite the increase in HTM limits, bond yields are likely to go up given the sheer size of the borrowing program for FY23. "We expect the 10 year to rise to 7-7.25 percent in H1 FY23," he said.

The 10-year G-sec yields breached 7 percent after the policy announcement. "We anticipate the 10 year yield to rise to as much as 7.4 percent over the course of H1FY23, as the market’s views on the number and timing of rate hikes crystallise," said Aditi Nayar, Chief Economist, ICRA Limited.

"Even as the governor hinted at utilising various tools to manage the government borrowing programme, comments on the yield curve being a public good were missing in his morning speech, suggesting that yields will be allowed to move up gradually," Nayar said.

Chowdhury of Acuité believes that the RBI has “finally bitten the bullet” and provided increased clarity on its monetary stance going forward.

The increase in the repo rate and the change in the stance from accommodative to neutral can happen as early in Jun-22 depending on the inflation and the growth data. "The market can brace for a 50 bps repo rate hike for the current financial year," he said.

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