The monetary policy committee (MPC) met on August 3 to 5 and reviewed the macroeconomic situation and its outlook. The MPC decided unanimously to increase the policy repo rate by 50 basis points to 5.4 per cent, with immediate effect. Consequently, the standing deposit facility (SDF) rate stands adjusted to 5.15 per cent; and the marginal standing facility (MSF) rate and the Bank Rate to 5.65 per cent. The MPC also decided to remain focused on withdrawal of accommodation to ensure that inflation remains within the target going forward, while supporting growth. This is the third consecutive rate hike after a 40 basis points in May and 50 basis points increase in June. In all, the RBI has raised benchmark rate by 1.40 per cent since May this year.
The MPC’s rationale for its decisions on the policy rate and the stance are as below. Against the prevailing adverse global environment, the MPC
- noted that domestic economic activity is resilient and progressing broadly along the lines of the June resolution of the MPC.
- Consumer price inflation has eased from its surge in April but remains uncomfortably high and above the upper threshold of the target.
- Inflationary pressures are broad-based and core inflation remains at elevated levels.
- The volatility in global financial markets is impinging upon domestic financial markets, including the currency market, thereby leading to imported inflation.
On the 50 bps rate hike the RBI Governor said, " If you look all around, 50 bps (hike) has become the new normal and large number of central banks are now hiking by 75-to-100 bps. So there is a tendency that 75-to-100 bps will takeover 50 bps. But in RBI, we take a very calibrated and measured view. We factor in the impact of the rate action on the aspect of growth and on our consumer urban and rural demand. Based on that we have taken a balanced call. Based on the prevailing and expected inflation-growth dynamics".
Monetary Policy Highlights
- Repo rate: MPC takes unanimous decision to raise benchmark lending rate by 50 bps to 5.40 pc
- Policy stance: MPC decides to focus on withdrawal of accommodative policy stance to check inflation
- Inflation projection: For FY23 retained at 6.7 pc on assumption of normal monsoon and crude oil at USD 105/barrel
- Economic growth projection: RBI retains its projection at 7.2 per cent for current fiscal
- Bank credit growth: It has accelerated 14 pc as against 5.5 pc year ago
- FDI inflows: It improved to USD 13.6 bn in Q1 this fiscal, against USD 11.6 bn in corresponding period last year
- Rupee: It has moved in orderly fashion, depreciating 4.7 pc till Aug 4; RBI remains watchful of INR movement
- Liquidity: Surplus liquidity in the banking system has come down to Rs 3.8 lakh crore, from Rs 6.7 lakh crore in April-May
- Deposit rates: Rise in term deposit rates should increase liquidity for financial sector
Key Takeaways from Monetary Policy:
The Indian economy has naturally been impacted by the global economic situation and our country has been grappling with the problem of high inflation. Financial markets have remained uneasy despite intermittent corrections. There has been large portfolio outflows to the tune of US$ 13.3 billion during the current financial year so far (up to August 3). Nevertheless, with strong and resilient fundamentals, India is expected to be amongst the fastest growing economies during 2022-23 according to the IMF, with signs of inflation moderating over the course of the year. Export of goods and services together with remittances are expected to keep the current account deficit within sustainable limits. The decline in external debt to GDP ratio, net international investment position to GDP ratio and debt service ratio during 2021-22 impart resilience against external shocks. "The financial sector is well capitalised and sound. India’s foreign exchange reserves, supplemented by net forward assets, provide insurance against global spillovers. Our umbrella remains strong" - says RBI Governor.
Decisions and Deliberations of the Monetary Policy Committee (MPC):
Against the prevailing adverse global environment, the MPC noted that domestic economic activity is resilient and progressing broadly along the lines of the June resolution of the MPC. Consumer price inflation has eased from its surge in April but remains uncomfortably high and above the upper threshold of the target. Inflationary pressures are broad-based and core inflation remains at elevated levels. The volatility in global financial markets is impinging upon domestic financial markets, including the currency market, thereby leading to imported inflation.
With inflation expected to remain above the upper threshold in Q2 and Q3, the MPC stressed that sustained high inflation could destabilise inflation expectations and harm growth in the medium term. The MPC, therefore, judged that further calibrated withdrawal of monetary accommodation is warranted to keep inflation expectations anchored and contain the second-round effects. Accordingly, the MPC decided unanimously to increase the policy repo rate by 50 basis points to 5.4 per cent. Consequently, the standing deposit facility (SDF) rate stands adjusted to 5.15 per cent; and the marginal standing facility (MSF) rate and the Bank Rate to 5.65 per cent. The MPC also decided to remain focused on withdrawal of accommodation to ensure that inflation remains within the target going forward, while supporting growth.
Domestic economic activity is exhibiting signs of broadening. A good progress of the southwest monsoon and kharif sowing would support rural consumption. Urban consumption is expected to benefit from the demand for contact-intensive services, better performance of corporates and improving consumer optimism. The increase in capacity utilisation, government’s capex push and large expansion in bank credit should support investment activity. According to RBI survey, manufacturing firms expect sustained improvement in production volumes and new orders in Q2:2022-23, which is likely to sustain through Q4. At the same time, the domestic economy faces headwinds from global forces - protracted geopolitical tensions; rising global financial market volatility; tightening global financial conditions; and global recession risks. Considering these factors, the real GDP growth projection for 2022-23 is retained at 7.2 per cent, with Q1 at 16.2 per cent; Q2 at 6.2 per cent; Q3 at 4.1 per cent; and Q4 at 4.0 per cent, with risks broadly balanced. Real GDP growth for Q1:2023-24 is projected at 6.7 per cent.
Inflation is expected to remain above the central bank's 6% threshold in the second and third quarters of this fiscal year, for which the MPC stressed that sustained high inflation could destabilise inflation expectations and harm growth in the medium. Given the elevated level of inflation and resilience in domestic economic activity, the MPC took the view that further calibrated monetary policy action is needed to contain inflationary pressures, pull back headline inflation within the tolerance band closer to the target, and keep inflation expectations anchored so as to ensure that growth is sustained.
Incidence of unseasonal and excessive rainfall can impact food prices, especially vegetable prices. Greater transmission of input cost pressures to selling prices across manufacturing and services sectors may also create fresh price pressures. Moreover, persistently elevated cost of living conditions could translate to higher wages and further price increases, especially if pricing power of firms strengthen. Taking into account these factors, and on the assumption of a normal monsoon in 2022 and average crude oil price (Indian basket) of US$ 105 per barrel, inflation is projected at 6.7 per cent in 2022-23, with Q2 at 7.1 per cent; Q3 at 6.4 per cent; and Q4 at 5.8 per cent, with risks evenly balanced. CPI inflation for Q1:2023-24 is projected at 5.0 per cent.
India's retail inflation
The retail inflation in India marginally eased to 7.01% on an annual basis in the month of June, from 7.04% in May, owing to easing crude and edible oil prices. Sequentially, the headline inflation slowed to 0.52% from 0.94% in May. The core inflation- excluding food and fuel segments- came in at 6% in June.
India's services growth
India's dominant services industry growth eased to a four-month low in July, as inflationary pressures and weaker demand restricted gains in business activity, according to a private survey. The S&P Global India Services Purchasing Managers' Index eased to 55.5 in July from 59.2 in June. The index slid from an 11-month high in June and hit the lowest level since March.
The risk of recession in a handful of Asian economies is rising as higher prices spur central banks to accelerate the pace of their interest rate hikes, according to the latest Bloomberg survey of economists. But, India has zero probability of slipping into recession, said the survey.
'No chance of India slipping into stagflation'
India's macroeconomic fundamentals are intact and there is no risk of the economy entering into recession or stagflation, finance minister Nirmala Sitharaman said earlier. "I would like to say there is no question of India getting into stagflation or, what it is called in the US, technical recession," she said, replying to a discussion in the Lok Sabha on the price rise. "There is absolutely zero probability of India slipping into recession."
Liquidity and Financial Market Conditions
The introduction of the standing deposit facility (SDF) in April 2022, which raised the floor of the liquidity adjustment facility (LAF) corridor by 40 basis points (bps), along with the policy repo rate hikes of May and June, have effectively resulted in withdrawal of accommodation by 130 bps. The weighted average call rate (WACR) – the operating target of monetary policy – has commensurately firmed up. At the longer end of the money market, interest rates on 91-day treasury bills, commercial paper (CPs) and certificates of deposit (CDs) have also moved higher since April. The rate hikes also triggered an upward adjustment in the benchmark lending rates by the banks. Term deposit rates are also increasing which should bode well for availability of funds with the banks in the context of sustained buoyancy in credit demand.
Surplus liquidity in the banking system, as reflected in average daily absorptions under the LAF (both SDF and variable rate reverse repo auctions), moderated to ₹3.8 lakh crore during June-July 2022 from ₹6.7 lakh crore during April-May. The sharp moderation in surplus liquidity from July 20, mainly on account of tax and capital outflows, resulted in money market rates firming up above the repo rate. To alleviate the liquidity stress, the RBI conducted a variable rate repo auction of ₹50,000 crore of 3 days maturity on July 26, 2022. RBI will remain vigilant on the liquidity front and conduct two-way fine-tuning operations as and when warranted – both variable rate repo (VRR) and variable rate reverse repo (VRRR) operations of different tenors, depending on the evolving liquidity and financial conditions.
During the current financial year (up to August 4), the US dollar index (DXY) has appreciated by 8.0 per cent against a basket of major currencies and the Indian Rupee has moved in a relatively orderly fashion depreciating by 4.7 per cent against the US dollar during the same period – faring much better than several reserve currencies as well as many of its EME and Asian peers. The depreciation of the Indian rupee is more on account of the appreciation of US dollar rather than weakness in macroeconomic fundamentals of the Indian economy. Market interventions by the RBI have helped in containing volatility and ensuring orderly movement of the rupee. We remain watchful and focused on maintaining stability of the Indian rupee said RBI Governor.
The Indian financial system remains resilient. This will help the economy in emerging out of the shadows of the pandemic and the impact of the war in Europe.
Merchandise exports grew in April-July 2022 while merchandise imports surged to record high on the back of elevated global commodity prices. Consequently, the merchandise trade deficit expanded to US$ 100.0 billion in April-July 2022. Provisional data indicate that demand for services exports, especially IT services, remained buoyant in Q1 despite global uncertainty. Exports of travel and transport services also improved in Q1:2022-23 on a year-on-year basis.
From the external financing perspective, net foreign direct investment (FDI) at US$ 13.6 billion in Q1:2022-23 was robust as compared to US$ 11.6 billion in Q1:2021-22. Foreign portfolio investment, after remaining in exit mode during Q1:2022-23, turned positive in July 2022. Reserve Bank has also used its foreign exchange reserves accumulated over the years to curb volatility in the exchange rate. Despite the resultant drawdown, India’s foreign exchange reserves remain the fourth largest globally. India’s foreign exchange reserves were US$ 573.9 billion as on July 29, 2022.
Regulatory Measures - Standalone Primary Dealers (SPDs)
Standalone Primary Dealers (SPDs) have played an important role in the development of financial markets in India. Considering their potential in further facilitating financial market development, the following two measures are being announced for the SPDs.
- It is proposed to enable Standalone Primary Dealers (SPDs) to offer all foreign exchange market-making facilities as currently permitted to Category-I Authorised Dealers, subject to prudential guidelines. This measure will provide customers with a wider set of market makers to manage their foreign currency risk. This will also increase the breadth of the forex market in India.
- Standalone Primary Dealers (SPDs) will be permitted to undertake transactions in the offshore Rupee Overnight Indexed Swap (OIS) market with non-residents and other market makers. This measure will supplement a similar measure announced in February this year for the banks. These measures are expected to remove the segmentation between onshore and offshore OIS markets and improve price discovery.
Managing Risks and Code of Conduct in Outsourcing of Financial Services
To manage risks in outsourcing of certain activities by the Regulated Entities (REs) in order to harmonise and consolidate the extant guidelines, a draft Master Direction on Managing Risks and Code of Conduct in Outsourcing of Financial Services will be issued shortly by RBI for comments from stakeholders.
Enabling Bharat Bill Payment System (BBPS) to Process Cross-Border Inbound Bill Payments
The Bharat Bill Payment System (BBPS) is an interoperable platform for standardised bill payments. This has transformed the bill payment experience for users in India. Over 20,000 billers are part of the system, and more than 8 crore transactions are processed on a monthly basis. RBI now proposed to enable BBPS to accept cross-border inward bill payments. This will enable Non-Resident Indians (NRIs) to undertake bill payments for utility, education and other such payments on behalf of their families in India. This will greatly benefit the senior citizens in particular.
Inclusion of Credit Information Companies (CICs) under the Reserve Bank-Integrated Ombudsman Scheme (RB-IOS) 2021 and Introduction of the Internal Ombudsman (IO) Mechanism
The Reserve Bank - Integrated Ombudsman Scheme (RB-IOS) has improved the customer grievance redress mechanism. The turnaround time of grievance redress under RB-IOS has declined considerably. To make the RB-IOS more broad based, RBI decided to include Credit Information Companies (CICs) under the RB-IOS framework. This will provide a cost-free alternative redress mechanism for grievances against CICs. Further, with a view to strengthen the internal grievance redress by CICs themselves, it has been decided to mandate the CICs to have their own internal Ombudsman (IO) framework.
Committee on MIBOR Benchmark
The Reserve Bank has been taking measures, from time to time, to develop the interest rate derivatives (IRD) market in India. Such measures have led to diversification of the participant base and increased use of IRD instruments, such as the Mumbai Interbank Outright Rate (MIBOR) overnight indexed swap (OIS) contracts. In view of the recent international efforts to develop alternative benchmark rates, it is proposed to set up a committee to undertake an in-depth examination of the issues, including the need for transition to an alternative benchmark for MIBOR, and suggest the way forward.
- All members of the MPC – Dr. Shashanka Bhide, Dr. Ashima Goyal, Prof. Jayanth R. Varma, Dr. Rajiv Ranjan, Dr. Michael Debabrata Patra and Shri Shaktikanta Das – unanimously voted to increase the policy repo rate by 50 basis points to 5.40 per cent.
- All members - Dr. Shashanka Bhide, Dr. Ashima Goyal, Dr. Rajiv Ranjan, Dr. Michael Debabrata Patra and Shri Shaktikanta Das, except Prof. Jayanth R. Varma - voted to remain focused on withdrawal of accommodation to ensure that inflation remains within the target going forward, while supporting growth. Prof. Jayanth R. Varma expressed reservations on this part of the resolution.
- The minutes of the MPC’s meeting will be published on August 19, 2022.
- The next meeting of the MPC is scheduled during September 28-30, 2022.
How economists and market experts reacted:
- Adhil Shetty, CEO at BankBazaar.com said, “The rise in repo rate coupled with the inflation is going to hit new and existing borrowers hard. A 140 basis points increase in the last few months means borrowers who were paying around 6.8-7 per cent interest will now be paying 8.2-8.4 per cent. This means that even for a 20-year loan, the amount of interest to be repaid is higher than the principal. If the EMI remains constant, the tenor for a 20-year loan can go up by as much as 8 years. As most lenders would not sanction this increase in tenor, it is a given that EMIs would increase. It’s now essential to have a repayment plan as going by the EMIs alone would mean a very high interest outflow.”
- D.R.E Reddy, CEO and Managing Partner at CRCL LLP said, “The RBI today increased the repo rate by another 50 bps to 5.40 per cent with immediate effect. With this move, the stage is set to return to pre-COVID levels with an end of the easy money era. There is absolutely zero probability of India slipping into recession. This will take the terminal rate to 5.90 per cent by the end of FY23. A normal monsoon, good crop year, easing of household inflation and de-escalation of tension between Russia and Ukraine will help keep crude prices in check.”
- Ravi Modani, Founder and CEO at 121 Finance said, “Policy announcement is on the higher end of expected lines, reflecting the RBI’s continued focus to maintain balance between growth and stability. We are right now in a situation where there is a considerable amount of challenge Indian economy faces, specially from global macro monetary policy and political developments. Any decrease in demand due to higher borrowing cost, should be offset by rural demand coming from a very good monsoon. At the same time this might impact the earnings of Q2 for most of the businesses. However, this is a very prudent decision to tread through this phase of global uncertainties with extreme caution and optimism coming from easing of inflation and Rupee maintaining its strength.”
- Motilal Oswal, MD and CEO at Motilal Oswal Financial Services said, “RBI in its latest MPC meeting has hiked the repo rate by 50 bps to 5.4 per cent – levels which was seen before the Covid-19 pandemic. The central bank raised the interest rate for the third consecutive month since May’22 by cumulatively 140 bps in its effort to contain inflation. Despite this sharp hike, RBI expects the inflation to remain above its comfort zone and has retained its CPI inflation forecast at 6.7 per cent for FY23. RBI expects India’s GDP growth to remain strong at 7.2 per cent in FY23. We believe, the commodity prices have cooled off including crude oil, the inflation may be peaking out. We expect RBI may not be very aggressive in its subsequent policy meets and being more data driven based on inflation numbers.”
Impact of Monetary Policy:
The policy decision will impact all loans – from home loans and car loans to personal loans. Fixed interest loans won't be affected, but all new loans and floating loan rates will be affected. The EMI's will be increased and dent the pocket of the consumers. For existing borrowers, the tenure will increase, which will translate into a higher interest burden. But, if the limit on tenure — usually retirement age for salaried employees and 65 years for the self-employed — gets breached, their EMI could also rise. Borrowers still on a loan linked to the marginal cost of funds-based lending rate, or MCLR, should shift to a repo rate-linked loan after careful calculation
However Fixed Deposit rates will rise. Ideally now, a depositor should consider locking funds in shorter-duration FDs in order to enjoy the benefit of higher interest rates in the coming months.
The repo rate is the rate at which the RBI lends money to banks. If the repo rate is high, the banks would have less money to lend, which in turn reduces the purchasing power of people. The reduction in purchasing power reduces demand which in turn reduces inflation.
Term deposit rates are also increasing which should bode well for availability of funds with the banks in the context of sustained buoyancy in credit demand.
Please click on the following link to read : Governor’s Statement - 5th August 2022 & Monetary Policy Statement, 2022-23 Resolution of the Monetary Policy Committee (MPC) August 3-5, 2022
Source: rbi.org.in, Economic Times, Business Standard & Indian Express