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RBI maintains hawkish pause

The Reserve Bank of India monetary policy committee (MPC) left the benchmark repo rate unchanged at 6.5%, with stance maintained at ‘withdrawal of accommodation’. The decision to pause was unanimous, with one dissent on the extension of the stance. The decision and commentary were in line with our expectations, as highlighted in the preview note.

On inflation, Governor Das acknowledged risks of a sharp upside to inflation in the near-term, driven predominantly by food segments due to inclement weather and seasonal forces. Together with higher foodgrains, pulses and few other protein sources, the upswing is being compounded by a skewed south-west monsoon, ongoing El Niño and built-up in global food prices due to geopolitical tensions. The MPC nonetheless is hopeful that fresh harvest arrivals will reverse part of the increase in perishables inflation, particularly vegetables, by 4Q23. We also note the recent run-up in commodity prices, especially crude oil, and adjustments in the domestic ATF (Aviation Turbine Fuel) prices. With Russian supplies priced below the prevailing market prices and FYTD average ~18-20% below FY23 average, material impact on inflation is unlikely. An ongoing moderation in core inflation – likely below 5% in Jul23 – also received a mention, signaling an absence of generalisation in price pressures. The cautious commentary was accompanied by an upward revision in the FY24 inflation forecast to 5.4% from 5.1% earlier, with changes in the 3Q and 4Q23 quarterly profiles (see table). 

Views on growth were upbeat, inferenced by the mention of good progress in the kharif sowing activity, firmer PMIs, industrial output, and consumer confidence indices. Deleveraged balance sheets of banks and private sector corporates were seen as providing a fertile ground to jumpstart the capex cycle, which is being led by the public sector for now. Certain key sectors including metals, petroleum, automobile, chemicals, iron and steel, cement and food and beverages have attracted investments, reflected in the improvement in the capacity utilisation in the manufacturing sector to 76.3%, above the long-term average of 73.7%. Net exports were expected to remain a drag. Assuming a normal monsoon season, the full-year FY24 growth forecast was maintained at 6.5%.


Policy outlook

The RBI MPC commentary on Thursday can be characterised as a pause with hawkish underpinnings. The commentary reflected the MPC’s vigilance on inflation, whilst highlighting the supply-driven nature of the recent run-up in food segments. Policymakers drew confidence from a moderation in core prints and expect a seasonal correction in food prices in 4Q23. This was balanced with an emphasis that further action might be warranted if inflationary expectations come unstuck or headline inflation stayed above the mid-point target of 4% on a durable basis. Cumulative rate hikes of 250bp are working its way through the economy. The evolving inflation trend is likely to be watched closely, pushing back rate cut expectations especially as trend inflation is likely to remain above 5% heading into FY25.  

Of note, the upcoming July inflation print is likely to be elevated at 6.7-7.0% yoy vs 2Q23 average of 4.6%. With monetary policy largely blunt in containing supply-side shocks, administrative measures have been already deployed and more are in the offing, for instance:
 

1. i) improving supplies of vegetables: improving inter-state movement of vegetables, especially tomatoes, besides increasing imports and sale through state agencies
2. ii) releasing stocks: the central government released additional 5mn tons of wheat and 2.5mn tons of rice under the open market sale scheme (OMSS) to calm prices. The reserve price for rice was also cut to INR2900/ quintal, to improve the take-up rate by traders; Current stocks are estimated at 28mn tons of wheat and 24mn rice as of Jul23;

iii) export bans and likely cuts in import duties: the ambit of export bans has been expanded to included non-basmati white rice, rice bran oil cakes etc., adding to last year’s wheat and broken rice restrictions. Add to this, cuts in the import duty for wheat might be considered after domestic prices rose to a six-month high;

24. iv) Stockholding limits on wheat with retailers, processors/ millers and wholesalers was imposed in Jun23 and will remain in place till Mar24. This marks a first such move since 2008 to dissuade hoarding. A similar move was imposed on select pulses/ lentils earlier;
25. v) direct fiscal support to farmers is likely to offset impact of the ban on export shipments

A temporary measure to manage liquidity

In concert with the central bank’s overall inflation-fight, a temporary measure to manage liquidity overhang was announced on Thursday. Banks have been asked to maintain an incremental cash reserve ratio (ICRR) of 10% with effect from 12Aug, on the increase in their NDTL (net demand and time liabilities) between 19May to 28Jul. The ICRR stands to be reviewed on 8Sep (ahead of the advance tax outflows) and is expected to draw ~INR1.0-1.1trn out of the system in the interim, just as INR 0.9trn is due to return on maturing VRRRs. The existing CRR remains unchanged at 4.5%. Being a temporary measure to restrain excess liquidity, there is unlikely to be material impact on banks’ profitability or margins. This move was last tapped in wake of the 2016 demonetisation, when the ICRR was pegged at 100%. This time around, the ICRR was considered after banks were reluctant to participate in the RBI’s VRRR (variable rate reverse repo) auctions, instead parking funds with the punitive SDF (Standing Deposit Facility).  

Domestic rupee liquidity has returned to a surplus balance in recent weeks owing to a confluence of factors, including:

1. withdrawal of INR 2000 notes from the system; at last check about 76% of the notes have been returned to the banking system, of which ~87% were deposited and rest exchanged;
2. Strong portfolio inflows on FYTD basis: FPIs have routed $17bn into equities and ~2bn into debt yet far this fiscal year;
3. Frictional drivers like an increase in government spending and return of currency to the banking system
4. Robust RBI dividends to the revenue coffers

Following the routine advance tax outflows in Sep23, we note that currency leakage is likely to increase during the seasonal festive period of Sep-Nov23, and concurrent state elections, helping to lower the liquidity balance.

Credit growth decomposition

After a period of stasis, nominal bank loan growth accelerated in FY23, with non-food credit rising 15% yoy, fastest pace in over eight years. Significant gains in 2022 also occurred in an environment of high inflation, and when adjusted for GDP deflators, real credit growth was more moderate at 5.7% yoy, suggesting higher working capital requirements likely added to the financing needs.

Besides pent-up demand after two years of the pandemic-driven slump in activity, substitution effects i.e., shift in funding requirements from the corporate bond markets (faster transmission of rate hikes into corporate bond yields) and offshore borrowings (sharp global central bank hikes) to the domestic banks, also boosted nominal credit growth.

Where is credit headed to?

Under the hood, all the sub-sectors excluding industry registered double-digit rise in FY23, led by 19% yoy increase in personal loans. Into Apr-Jun23 (1QFY24), these trends persisted, with personal loans growing 20% yoy besides a sharp increase in bank lending to non-bank finance companies (NBFCs), that led services to jump 23% yoy. Encouragingly, bulk of the incremental loan disbursements for the industrial sector has been in the MSMEs space, as its share has continued to rise in the past 4-5years, whilst that to large enterprises has moderated. The sectoral breakdown saw loan growth in the heavyweight infrastructure sector rise 8% yoy in FY23, followed by basic metals and metal products at 10% after three consecutive years of decline.

Two trends in the overall credit growth are striking.

Firstly, the share of personal loans in total bank credit has surged to 29% in FY23, from ~22% in FY18. A deeper dive shows that even as mortgages, under personal loans, rose a strong 15.4% last year, it’s share has fallen from 53% in FY18 to 47% in 1QFY24. This has been replaced by an increase in the share of personal loans excluding mortgages, including credit card outstanding. This explains the central bank’s calls for higher due diligence amongst banks to track rise in their ex-mortgages loan book including the unsecured obligations.

Secondly, banks’ lending to NBFCs rose 27% y/y in FY23 and up another 30% in Apr-Jun23, reaching a record high in nominal terms. Banks have emerged as the main the main source of funds for the non-bank institutions, as their share is up from 35.6% in Mar20 to 41.2% in Mar23, displacing market borrowings as the dominant share, with its share falling by ~5% to 38.8% in Mar23. The lending book of NBFCs is largely mirroring that of banks, with personal rising 31% yoy, surpassing the 16% yoy growth in gross advances in FY23. The personal loans portfolio made up a third of the NBFCs total loans in FY23. The broader health of non-banks has improved since the 2018 crisis, with the GNPAs of public sector NBFCs at 2.8%, below the private sector’s at 5.5%, according to the RBI’s Financial Stability Report. Concurrently, the aggregate NNPA ratio moderated to 1.3%, besides the provisioning coverage ratio (PCR) up to 70.4 in the last FY.

While the underlying loan growth momentum remains strong, we expect some moderation this year: a) comparing to a high base; b) working capital requirements are easing as non-food producer price inflation slows; c) higher due diligence from the central bank on the unsecured books of banks (likely by extension non-banks); d) ahead of the elections, fresh commitments by the private sector might enter a wait-and-watch mode, excluding sectors that have linkages to the public sector capex program, including cement/ steel, O&G, power and metals etc.


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