What is RBI expected to do in the upcoming monetary policy and why is it likely to keep the repo rate unchanged? If that happens, how could lending rates be impacted?
The Reserve Bank of India’s (RBI) six-member Monetary Policy Committee (MPC), which is scheduled to meet from February 6 to 8, is likely to keep the repo rate – its key policy rate – unchanged for the sixth consecutive time at 6.5 per cent to meet the 4 per cent consumer price-based inflation (CPI) target. The committee is also likely to retain the monetary policy stance as ‘withdrawal of accommodation’.
What is RBI expected to do in the upcoming monetary policy?
The rate-setting panel of the RBI is expected to keep the repo rate – the rate at which RBI lends money to banks to meet their short-term funding needs — steady at 6.5 per cent in the policy decision which will be announced on February 8. If the RBI maintains the status quo in the upcoming policy, it would mark one full year of the repo rate remaining steady at 6.5 per cent. The central bank last increased the repo rate by 25 basis points (bps) on February 8, 2023, to 6.5 per cent. One basis point is one-hundredth of a percentage point.
The central bank is also likely to maintain the monetary policy stance as a ‘withdrawal of accommodation’, economists said.
The RBI’s monetary policy will be announced a few days after the US Federal Reserve announced its monetary policy decision in which it left the benchmark interest rates unchanged at 5.25 per cent – 5.5 per cent and suggested that there was no hurry to change rates. Markets earlier anticipated that the US central bank may start cutting interest rates from March this year.
A few economists expect the RBI to announce some liquidity measures to ease the tight liquidity condition in the banking system.
“Going forward, the upcoming RBI policy is expected to give some guidance on liquidity. Currently, the gap between incremental credit and deposit in FYTD (financial year till date) 2024 stands at Rs 3.6 lakh crore. Thus, near term pressure on liquidity cannot be ruled out unless RBI comes up with some measures to improve the durable liquidity of the system,” said Dipanwita Mazumdar, Economist, Bank of Baroda.
Liquidity conditions have remained tight in the banking system for some time due to lower government spending, higher tax outflows and slower bank deposit growth. On January 24, the liquidity deficit hit a record high of Rs 3.46 lakh crore.
Why is RBI likely to keep the repo rate unchanged?
The RBI has been maintaining that its aim is to bring CPI inflation to 4 per cent, and until that is achieved on a sustainable basis, its focus will be to remain disinflationary. In December, CPI inflation, or retail inflation, surged to a four-month high of 5.69 per cent in December driven by higher prices of food items such as pulses, spices, fruits and vegetables. In November 2023, CPI inflation stood at 5.55 per cent. Although headline inflation has come within the 2-6 per cent band set by the government for the RBI, it still remains above the 4 per cent target.
RBI has projected CPI inflation at 5.4 per cent for FY24, with Q3 at 5.6 per cent and Q4 at 5.2 per cent.
“We maintain our view that the RBI MPC will keep the policy rate unchanged at the February 8 policy meeting at 6.50 per cent, sound optimistic on growth, recognize the sharp fiscal consolidation in the interim budget, and reiterate the commitment to the 4 per cent headline inflation target,” Goldman Sachs said in a research report.
For FY24, the RBI’s real GDP growth forecast is 7 per cent. A recent report by the finance ministry said that the country’s economy is likely to grow at over 7 per cent in the coming years and is expected to become the third-largest economy in the world in the next three years, with a GDP of $5 trillion.
High frequency data in Q4 (October-December quarter) of the calendar year (CY) 2023 shows improvement in investment activity and survey data has remained strong with both services and manufacturing PMIs remaining well above 50, the report by Goldman Sachs said.
“We expect the RBI to keep the policy repo rate unchanged until Q3 (July-September quarter) of CY24,” the report said.
Nomura expects 100 bps of rate cuts, starting from August, with risks of earlier cuts.
What about the monetary policy stance?
Economists believe that the RBI will continue with its monetary policy stance as ‘withdrawal of accommodation’ on February 8.
“While financial markets will be closely watching the (RBI) Governor’s comments and the RBI’s actions on liquidity, we think that liquidity will continue to be actively managed by the RBI consistent with the monetary policy stance of ‘withdrawal of accommodation’,” Goldman Sachs said.
“While significant progress has been made on the core inflation front, we think the upcoming February 8 monetary policy meeting may be too early for the RBI to make any changes to the existing monetary policy stance, particularly given that the (US) Fed remains noncommittal at this stage as to when to start its own easing cycle,” said Kaushik Das, Chief Economist, India & South Asia, Deutsche Bank.
The RBI will likely continue providing liquidity through 14-day VRR (variable repo rate) to reduce over-tightening risks, but a formal change to the monetary policy stance may have to wait till April, Das said in a recent note.
What happens to lending rates if the repo rate is unchanged?
With the RBI expected to leave the repo rate unchanged at 6.5 per cent, all external benchmark lending rates (EBLR) that are linked to the repo rate will not rise. It will again give relief to borrowers as their equated monthly instalments (EMIs) will not increase.
However, lenders may raise interest rates on loans that are linked to the marginal cost of fund-based lending rate (MCLR), where the full transmission of 250 bps hike in the repo rate between May 2022 and February 2023 has not happened.
In response to the 250 bps hike in the policy repo rate, banks have increased their EBLRs by a similar magnitude, while the one-year median MCLR increased by 155 bps during the period May 2022–December 2023. Concomitantly, the weighted average lending rate (WALR) on fresh and outstanding rupee loans increased by 183 bps and 108 bps, respectively, from May 2022-November 2023.