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RBI extends pause
 

• Decision and economic assessment

The RBI monetary policy committee (MPC) kept all the policy parameters unchanged – repo rate at 6.5% (unanimous), the corridor, as well as the ‘withdrawal of accommodation’ stance (5:1 split), in line with our expectations (preview).

The policy commentary reinforced the MPC’s optimism on the growth prospects, while inflation is back within the target tolerance level (2-6%), providing a Goldilocks mix for the authorities and the headroom to keep rates on hold. The MPC retained the FY24 real growth forecast at above-consensus 6.5%, one of the strongest amongst the regional peers, after 7.2% growth in FY23, drawing strength from strong farm output, buoyant services, government capex, lower commodity prices, and robust credit growth, which together, should overcome the risks from weak external demand and geopolitical tensions.

While the inflation commentary was less cautious than in April, the MPC remained vigilant. Notwithstanding inflation set to ease to ~4.5-4.6% this quarter, the Governor said, “headline inflation still remains above the target and being within the tolerance band is not enough. Our goal is to achieve the target of 4.0 per cent, going forward”. Members will monitor a) volatile food segments and spillover from global price trends, including milk, sugar, rice, and crude oil prices, etc.; b) spatial and temporal distribution of monsoon. The FY24 inflation projection was dialled down to 5.1% from 5.2% to account for the 50bp reduction in 2Q23 inflation outcome (see table). The latest inflationary expectations survey captured a further moderation.
 

• Outlook

 
The Goldilocks backdrop – strong growth, narrow, within-target inflation, external stability and stable rupee – led the RBI MPC to extend its wait-and-watch mode, as it monitors the band of uncertainty over the inflation outlook before deciding to either tweak the stance or pivot towards a cut. This comes against the backdrop of the Australian weather bureau raising the probability of an El Nino occurrence, besides action from the global central banks that reflects vigilance over inflation as well as financial stability risks.

As the RBI maintained its strong GDP projection (DBSf: 6%), the supportive recovery prospects lower the urgency for a quick turn in the policy direction. A pause will allow for the lagged impact of past hikes to filter through to the real economy, with policymakers keen to keep real rates in black. End-FY24 inflation forecast at 5.2% and repo rate at 6.5% leaves the real rate at ~130bp, reversing the average -140bp between 2020 and 2022. We don’t expect a change in the policy rate within this calendar year.

Authorities plan to address banking liquidity conditions via market operations rather than durable tools. The fall in the surplus in Apr-May was put to pandemic-era maturing TLTROs, besides seasonal factors like higher currency in circulation and a step up in government spending, whilst balances have since improved due to the INR2k banknote cancellation (read here; 50% of outstanding INR2K value is back with the banks according to the RBI), FX intervention stance and lower government cash balances with the RBI. In all, a mix of need-based variable repo and variable reverse repo auctions are likely to be tapped to keep liquidity close to a non-inflationary neutral balance during the year.


Inflation dynamics – Hike in MSPs and fuel price adjustment

The government raised the minimum support price (MSP) for the summer/ kharif crop by an average of 7.4% yoy vs 6% the year before, the strongest in five years. Under this adjustment, the hike for the largest foodgrain grown during the kharif season – rice/common paddy crop – was at 7% vs 5.1% in FY23, which in absolute rupee terms was the second highest in a decade. The key pulse variety will rise by 10.4%, and the rest of the crops in the 5.5-10.5% range.

This MSP hike is seen as a pre-emptive step to compensate farmers ahead of an uncertain impact from an impending El Nino onset and monsoon vagaries (read India: Weather watch and impact). The Australian weather bureau now sees a 70% chance of an El Nino weather pattern this year, raising its criteria to ‘alert’ on the development from ‘watch’ before. The weighted average of cost of production of rice rose by 4.5-7.3% across projected states last year, squaring with the scale of adjustment in the MSPs announced, largely along the lines of the Commission for Agricultural Costs and Prices' (CACP) recommendation.

The correlation of food CPI inflation with the average MSP of summer crops/paddy MSP is 0.5-0.6. However, the net impact on the headline inflation will depend on energy, transportation, services, and demand-pull price pressures. Notably, this MSP adjustment also comes ahead of a slew of state elections, including Madhya Pradesh, Rajasthan, and Chhattisgarh, and general elections in May 2024. However, we note that the scale of increase in the MSP rates is less than those witnessed in the past pre-election years, which was in the range of 32% for paddy in FY09 and 16% in FY13.

Separately, the public sector oil marketing companies are expected to lower retail fuel prices of petrol and diesel; they reportedly made up for under-recoveries over the past year. Despite the recent fall in global Brent prices/India's benchmark, domestic pump prices have remained unchanged since May 22 due to rigidity in local taxes. Concurrently, non-subsidized commercial LPG, kerosene, and aviation turbine fuel prices have been on the retreat since peaking in mid-22 (see chart above).


Fiscal deficit meets revised goalpost

FY23 fiscal deficit narrowed to -6.4% of GDP, as outlined in the revised numbers in February’s Budget. The underlying math saw larger support from non-tax revenues and a moderate reduction in revenue expenditure, which helped to offset lower divestment proceeds and a higher capex outlay.

The fiscal deficit reached 7.5% of the full-year target in Apr23, the first month of FY24, slightly wider than 4.5% in the comparable period last year. Under subsidies, early disbursements towards fertilisers jumped (21% of budgeted) in the first month of the FY, whilst food and fuel were moderate, under 5%. Authorities are already flagging the risk that this year’s outlay towards fertiliser subsidy might overshoot the budget by as much as INR500bn to INR2.25trn, with INR1.1trn of the total allocation already approved for disbursements towards the ongoing summer/ kharif crop.

Early indications are encouraging on the revenue end, especially on GST collections (see chart above) and RBI dividend transfer. Apr23 collections (support from end-FY in Mar) jumped to a record high of INR1.9trn before normalising to INR1.6trn (12% y/y) in May. Add to this, the RBI had announced plans to transfer INR874bn (0.3% of GDP) to the government’s coffers, higher than last year’s INR303bn as well as FY24’s budgeted numbers. While the surplus transfer is a positive for this year’s fiscal math, there are other pressures in the pipeline by way of higher fertiliser subsidy outlay and softer nominal GDP growth. We don’t expect an overshoot of the budgeted fiscal deficit target in FY24, with any incremental pressure likely to be met by a reprioritisation amongst the spending heads. 


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