India: RBI - Rate pause continues, hawkish tone rises

Key takeaways:

• The Reserve Bank of India (RBI) continued its pause on rate hikes, keeping the repo rate at 6.50% as well as its stance of ‘withdrawal of accommodation’, with statements conveying this to be a hawkish hold.

• Markets had expected no changes in the policy and did not show any major moves across asset classes. Yields inched up 2-3 bps in usual market activity.

• With the yield curve expected to remain flattish for 2023, accrual gains in the 3-5 year segment offer the optimum risk reward for fixed income investors. 

What happened?

The Reserve Bank of India (RBI) paused on rates for the third consecutive time, after continuously hiking rates by a total of 250 bps to 6.50% in February 2023. The Standing Deposit Facility Rate (SDFR) stays at 6.25% and the Bank Rate at 6.75%.
 
It also maintained the overall policy stance of ‘withdrawal of accommodation’, with one member dissenting; similar to the previous meeting. The RBI Governor, Shaktikanta Das, in his address repeatedly stressed RBI’s commitment to align CPI to a 4% target on a durable basis.
 
GDP growth forecasts were unchanged for fiscal year 2023/24 (FY 2023-24) at 6.5%, with quarterly breakups of 8%, 6.5%, 6% and 5.7% respectively.
 
However, Consumer Price Inflation (CPI) projections were raised for FY 2023-24 by 30 bps to 5.4%, with current quarter forecasts rising a full 100 bps to 6.2%. RBI estimates this to fall to 5.2% levels from Q1 2024 onwards.
 
Governor Das, commenting on the recent vegetable price increases which have caused the upward revision in inflation, said, ”We do look through idiosyncratic shocks but if such idiosyncrasies show signs of persistence we have to act”.
 
An unexpected move to mop up liquidity came from an increase in the Cash Reserve Ratio (CRR) for scheduled banks. An increase of 10% was imposed, though only on the incremental increase in the net demand and time liabilities. This will initially be valid for one month.
 
On the external sector front, statements made by the Governor expressed comfort on the Current Account Deficit (eminently manageable), flows (FPI flows buoyant) as well as on the reserves position which have again topped USD600bn.
 
Many other regulatory measures were announced as well, the most important being to enhance digital payment experiences through the Unified Payments Interface, both in the offline mode and through AI-powered systems. 

How did markets react?

Fixed income markets did not show any reaction to the status quo policy. Yields on 10-year government paper remained flat at 7.17%, while the 5-year and the 3-year papers went up by just 2-3 bps.
The INR was also flat at 82.82 vs the USD at the time of writing.
 
Equity markets corrected marginally by 0.5% (Nifty 50), after having risen over 6.5% in the previous 3 months. The financial sector benchmark Bank Nifty Index was down by about 1% in mid-day trading. 

What does it mean for investors?

Rising vegetable and food prices have been bumps in the path of monetary policy. Recent crude oil spikes will add to these woes for the central bank. In light of these conditions, the RBI has not only raised inflation projections but also brought in temporary liquidity control measures.
 
While food inflation is more a supply-side phenomenon, which cannot be controlled with monetary policy, it plays an important role in the national elections scheduled for mid-2024. Increased hawkishness from the central bank will be expected.
 
Banking liquidity had increased recently on two major factors. One, as mentioned in the last CIO Memo - India: RBI pauses at 6.50%, likely end to hiking cycle, was the INR 2,000 currency note being taken out of circulation, resulting in deposits increasing into the banking system. Secondly, foreign portfolio buying has topped USD17bn YTD, and has turned the system flush with liquidity. These have also kept overnight call rates lower than repo rates on most days. The incremental cash reserve ratio (I-CRR) increase is an effort to absorb approximately INR1tn of this surplus, as per the Governor’s press conference. This will still leave the banking industry with enough to serve credit needs.
 
Finally, the most important takeaway from the policy is that any expectations of rate cuts will now be extinguished or pushed into mid-2024. The reiteration of the objective to contain inflation within 4% effectively puts an end to that expectation for now. The food shocks are expected to be transient, as stated by Deputy Governor Patra in the press conference. However, with the El Nino effects intensifying for the rest of the monsoon season, an extended persistence of these prices could lead to some hardening of bond yields.   
The yield curve is expected to continue to stay flattish for the rest of 2023. Real yields will remain comfortably in the positive zone as well. Thus, investors in fixed income should also continue to benefit from accruals on their investments. Investments in the 3-5 year segment appear to offer the best risk reward. 

The CIO Memo above is available to download. Please refer to the Important Information at the end of the memo for disclosures and risk warnings.

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