As expected, the Monetary Policy Committee (MPC) maintained status quo on the repo rate, kept the stance accommodative, raised its inflation forecast and cut its growth projection for FY23, amidst the uncertainty created by the Russia-Ukraine conflict.
However, with a clear prioritisation of inflation over economic growth, the committee revised its comments around the monetary policy stance, clarifying that it would focus on the withdrawal of accommodation going ahead. The decision on the stance was unanimous, unlike the past few policy reviews.
Moreover, the committee normalised the width of the liquidity adjustment facility (LAF) corridor to pre-pandemic levels by unexpectedly introducing the Standing Deposit Facility (SDF) at 3.75% as the floor rate, even as the fixed rate reverse repo (FRRR) was kept unchanged at 3.35%. With 80% of surplus liquidity being absorbed under the variable rate reverse repos (VRRR) at rate closer to the repo rate of 4.0%, the introduction of SDF at 3.75% will improve the returns on the balance liquidity that was being placed by banks at reverse repo rate of 3.35%. This could also lead to an increase in the overnight call money rates and boost the profitability of banks. At the same time, it could lead to a further increase in short-term rates, increasing the borrowing costs linked to such rates.
The MPC shaved its GDP growth projections for FY23 from 7.8% to 7.2%, in line with our estimate for this fiscal. The growth forecasts made by the committee in April 2022 have undergone a downward revision compared to its February 2022 estimates for each of the quarters of FY2023: Q1 FY23 (to +16.2% from +17.2%), Q2 FY23 (to +6.2% from +7.0%), Q3 FY23 (to +4.1% from +4.3%) and Q4 FY23 (to +4.0% from +4.5%). While our annual growth forecast is in line with the MPC’s, we are somewhat more optimistic on the outlook for H2 FY23. At the same time, we foresee a lower growth in Q1 FY23, given the expected adverse impact of high commodity prices on corporate margins.
The committee highlighted the risks stemming from elevated commodity prices, tightening global financial conditions, uncertainties related to the pace of policy normalisation in advanced economies, continued supply-side disruptions and flagging global demand. However, it sounded upbeat on investment demand, and highlighted the Government of India’s thrust on capex, improving capacity utilisation levels and deleveraged corporate balance sheets. Interestingly, the capacity utilisation of 72.4% for Q3 FY22 has surprised on the upside; we expected such levels to be reached in the subsequent quarter.
The committee substantially raised its FY23 inflation forecast to 5.7% from 4.5% earlier, similar to our own expectation of 5.6%. The MPC highlighted that its projection was based on the assumption of the price of the Indian basket of crude oil averaging at US$100/ barrel, while ours in US$105/ barrel. Compared to its Feb 2022 projections, the MPC has now raised the CPI inflation forecast for all quarters of FY2023: Q1 FY23 (to +6.3% from +4.9%), Q2 FY23 (to +5.8% from +5.0%), Q3 FY23 (to +5.4% from +4.0%) and Q4 FY23 (to +5.1% from +4.2%). Thus, while inflation is set to moderate over the course of FY2023, it is expected to remain uncomfortably high at above 5.0%
Overall, with the focus shifting to inflation management over supporting growth, and the modification in the wording on the policy stance, the MPC has clearly telegraphed an imminent change in the stance. We see a near certainty of it being revised to neutral from accommodative in the June policy review. We see this as being followed by a shallow rate hike cycle, with the repo rate being increased by 25 bps each in August and September, entailing a negative real policy rate throughout FY23.
Our assessment suggests that the estimates of tax revenues made in the FY23 BE are rather conservative in light of the substantial overshooting that has taken place in FY22. This offers space for a rollback in excise duties back to the pre-pandemic levels, to moderate the anticipated uptrend in inflation and prevent excessive tightening of policy rates as well as the household budgets and corporate margins.
The RBI governor highlighted that the liquidity overhang will be withdrawn in a gradual and calibrated manner over a multi-year time frame. Moreover, the increase in HTM limits by 1% could create an additional headroom of 1.6-1.7 trillion for banks to hold the government securities without marking them to market in a rising bond yield scenario, and thereby preventing any losses. This could improve the appetite of banks for government securities and facilitate the large borrowing programme of central and state governments while moderating the rising in yields. However, given the overall size of the government borrowings, the absorption of the large supply could remain a challenge.
We had predicted that the 10-year G-sec yield would cross 7.0% in April, which it did after the policy announcement. We anticipate the 10-year G-sec yield to rise to as much as 7.4% over the course of H1 FY23, based on our forecast of a total repo increase of 50 bps in this fiscal year.
(The writer is chief economist, Icra)
