India: Inflation becomes a priority at the RBI
- India’s Monetary Policy Committee (MPC) left the key benchmark rate unchanged at 4%
- Action lay elsewhere. The policy corridor was restored to the pre-pandemic level
- A newly introduced Standing Deposit Facility will mark the floor
- The inflation forecast was increased sharply, and growth was revised down
- The guidance leaves the door open for a change in stance at the June review
In a unanimous decision, India’s Monetary Policy Committee (MPC) left the key benchmark rate unchanged at 4.0% as well as maintained an accommodative stance.
Action lay elsewhere as firstly, the policy guidance was tweaked to focus on “withdrawal of accommodation to ensure that inflation remains within the target going forward, while supporting growth” which essentially takes inflation back to the centre of the policy dashboard.
Secondly, the width of the Liquidity Adjustment Facility (LAF) corridor, around the repo rate, was restored to pre-pandemic levels of 50bp, bookended by the newly instituted Standing deposit facility (SDF) rate at 3.75% and the Marginal standing facility (MSF) was retained at 4.25%. The SDF rate is tantamount to an indirect tightening of 40bp, as the fixed reverse repo rate stays at 3.35%. To recall, the 2014 Urjit Patel committee discussed the SDF as an instrument that helped define a floor rate in the inter-bank market, especially in liquidity surplus conditions, as is the case presently. In essence, this allows for the absorption of liquidity from the system without the binding constraint of providing collateral in exchange. The use of SDF will be on the discretion of the banks, in contrast to other instruments like the cash reserve ratio, reverse repo etc which are at the discretion of the central bank.
Inflation concerns returned to the centre stage even as the durability of recovery remains a worry. This trade-off was underscored by a 60bps cut in the growth projection and a 120bps increase in the inflation forecast, backed by a sharp US$25pb increase in the underlying crude oil price assumption.
Departing from previously held expectations for inflation to moderate, the FY23 CPI forecast was revised up to 5.7% vs 4.5% owing to a) notwithstanding hopes for a normal monsoon, food commodities have risen through wheat, edible oil, feedstocks, etc due to geopolitics and supply shocks; b) direct and indirect impact of elevated crude - average crude oil price (Indian basket) assumption was revised up to $100pb vs $75pb before. Policymakers also added that the inflation trend was fraught with risks and largely contingent on commodity price movements.
The March 2022 survey saw median inflationary expectations of urban households, for 3months and 1year ahead, increase marginally by 10bps. Separately, the RBI’s industrial outlook survey also reflected manufacturing firms expecting to increase their selling prices in the Apr-Jun22 quarter.
On growth, the RBI derived comfort from a swift improvement in the Covid caseload, which allowed for contact intensive activities to gain traction, better confidence, and business surveys, pick up in capacity utilisation surveys and rebound in multiple high-frequency indicators. Geopolitics had, however, cast a shadow through confidence and commodity channels. To reflect this local-global mix, the FY23 GDP growth forecast was cut to 7.2% from 7.8% before.
The Monetary Policy Report was also concurrently released with underlying assumptions we highlight below:
The RBI maintained that the policy response in light of ‘tectonic shifts’ was to be ‘pre-emptive and re-calibrated dynamically’ as well as adopt a ‘nuanced and nimble-footed approach to liquidity management’. Key takeaways were:
- The interest rate for around 80% of the total liquidity absorbed under the LAF during Jan-Mar22 had firmed up close to the policy repo rate due to the rebalancing of liquidity through the variable rate reverse repo (VRRR) auctions, which continues to lower the relevance of the fixed reverse repo rate
- The SDF is introduced as the floor of the LAF corridor, providing symmetry to the operating framework of monetary policy.
- Providing forward-looking guidance, the RBI also added that it “will engage in a gradual and calibrated withdrawal of this liquidity over a multi-year time frame in a non-disruptive manner beginning this year”. This suggests that liquidity conditions will be kept in surplus and not return to a neutral balance in a hurry, which was maintained under previous Governors, despite inflation concerns
The central bank MPC’s policy guidance marked a shift from their long-standing strong dovish disposition, taking inflation back to the centre of their policy dashboard.
The tweak in the guidance to acknowledge the need to start withdrawal of accommodation leaves the June rate review live for a change in the stance to neutral. With upside risks to the 2QFY23 inflation projection, the first repo rate hike might be delivered in August and thereafter towards end-2022. We retain our expectations for 75bps worth rate hikes in FY23, concentrated in second half of the year. Local considerations will still trump global policy normalisation i.e., even in the face of the US Fed pursuing an aggressive rate hiking cycle, it is amply clear that the RBI is unlikely to respond with a larger or faster quantum of hikes.
The hawkish surprise from the central bank led 10Y INR (generic) bond yield to test past 7% to three-year high along with an uptick in 2Y and money market rates. Besides the extension and increase in the held-to-maturity requirement for banks that will potentially draw additional demand for bonds, markets still await clear signals on the shape and form of the central bank’s support. For banks, the present limit for Held to Maturity (HTM) category for FY23 will be raised to 23% (vs 22% earlier) of NDTL until March 31, 2023. Add to this, banks will be allowed to include eligible SLR securities acquired between April 1, 2022 and March 31, 2023 under this enhanced limit. Thereafter the HTM limit will return to 19.5% in a phased manner starting from June 30, 2023.
Revising inflation forecasts
CPI inflation in March, out on Monday, is on course to breach the central bank’s target range, defying expectations of a let-up on base effects. We expect March inflation to rise 6.3% yoy, quickening from 6.1% the month before. The moderating impact of base effects is likely to be offset by a sequential rise in the food segment alongside the trickle-down impact of higher energy commodity prices as pump prices and LPG have been raised incrementally since late March. Yet, the full impact of the pump fuel and LPG price increases alongside higher natural gas are likely to be reflected from April onwards.
There are additional pipeline risks. First, diesel and petrol prices are up 11.5% and 10.5% respectively in early April vs Dec21 (fuel types have a combined weight of 2.3% in the CPI basket), doubling of natural gas, 5.5% increase in domestic LPG, commercial LPG adjusted up so has CNG, price increases for bulk buyers of fuel. Second, the pass-through of higher input costs (logistics and raw material costs) faced by manufacturers, for instance, the FMCG sector, and service providers besides imported pressures from a rally in the broader commodity universe.
Third, other segments like fertilisers, utilities, edible oils, wheat, etc., will also exert upside pressure. Cost-push forces account for much of the inflationary push for now, while demand is gradually on the mend. But there are clear signs that inflation is increasingly becoming more persistent and generalised, necessitating an appropriate policy response. CPI is likely to stay elevated at around 6% in April-May, assuming retail fuel increases by another INR5-7bl, likewise in June-July, with monsoon strength as the other catalyst. We lift the FY23 average to 5.9% yoy with upside risks, vs our previous forecast at 5.4%.
India’s Financial Conditions Index (FCI) points to still easy conditions
We update our proprietary Financial Conditions Index (FCI) with the latest market prices spanning FX, credit, equity, and bond markets. The aggregate index shown in the chart below suggests that financial conditions are accommodative and conducive to recovery. We will be watchful for any spillover from policy normalisation by global central banks. See Mapping India’s Financial Conditions Index (FCI) for details on the study.
To read the full report, click here to Download the PDF.
Subscribe here to receive our economics & macro strategy materials.
To unsubscribe, please click here.
The information herein is published by DBS Bank Ltd and/or DBS Bank (Hong Kong) Limited (each and/or collectively, the “Company”). This report is intended for “Accredited Investors” and “Institutional Investors” (defined under the Financial Advisers Act and Securities and Futures Act of Singapore, and their subsidiary legislation), as well as “Professional Investors” (defined under the Securities and Futures Ordinance of Hong Kong) only. It is based on information obtained from sources believed to be reliable, but the Company does not make any representation or warranty, express or implied, as to its accuracy, completeness, timeliness or correctness for any particular purpose. Opinions expressed are subject to change without notice. This research is prepared for general circulation. Any recommendation contained herein does not have regard to the specific investment objectives, financial situation and the particular needs of any specific addressee. The information herein is published for the information of addressees only and is not to be taken in substitution for the exercise of judgement by addressees, who should obtain separate legal or financial advice. The Company, or any of its related companies or any individuals connected with the group accepts no liability for any direct, special, indirect, consequential, incidental damages or any other loss or damages of any kind arising from any use of the information herein (including any error, omission or misstatement herein, negligent or otherwise) or further communication thereof, even if the Company or any other person has been advised of the possibility thereof. The information herein is not to be construed as an offer or a solicitation of an offer to buy or sell any securities, futures, options or other financial instruments or to provide any investment advice or services. The Company and its associates, their directors, officers and/or employees may have positions or other interests in, and may effect transactions in securities mentioned herein and may also perform or seek to perform broking, investment banking and other banking or financial services for these companies. The information herein is not directed to, or intended for distribution to or use by, any person or entity that is a citizen or resident of or located in any locality, state, country, or other jurisdiction (including but not limited to citizens or residents of the United States of America) where such distribution, publication, availability or use would be contrary to law or regulation. The information is not an offer to sell or the solicitation of an offer to buy any security in any jurisdiction (including but not limited to the United States of America) where such an offer or solicitation would be contrary to law or regulation.
This report is distributed in Singapore by DBS Bank Ltd (Company Regn. No. 196800306E) which is Exempt Financial Advisers as defined in the Financial Advisers Act and regulated by the Monetary Authority of Singapore. DBS Bank Ltd may distribute reports produced by its respective foreign entities, affiliates or other foreign research houses pursuant to an arrangement under Regulation 32C of the Financial Advisers Regulations. Singapore recipients should contact DBS Bank Ltd at 65-6878-8888 for matters arising from, or in connection with the report.
DBS Bank Ltd., 12 Marina Boulevard, Marina Bay Financial Centre Tower 3, Singapore 018982. Tel: 65-6878-8888. Company Registration No. 196800306E.
DBS Bank Ltd., Hong Kong Branch, a company incorporated in Singapore with limited liability. 18th Floor, The Center, 99 Queen’s Road Central, Central, Hong Kong SAR.
DBS Bank (Hong Kong) Limited, a company incorporated in Hong Kong with limited liability. 13th Floor One Island East, 18 Westlands Road, Quarry Bay, Hong Kong SAR
Virtual currencies are highly speculative digital "virtual commodities", and are not currencies. It is not a financial product approved by the Taiwan Financial Supervisory Commission, and the safeguards of the existing investor protection regime does not apply. The prices of virtual currencies may fluctuate greatly, and the investment risk is high. Before engaging in such transactions, the investor should carefully assess the risks, and seek its own independent advice.