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The six-member Monetary Policy Committee (MPC) of the Reserve Bank of India (RBI) on Friday decided to increase the policy repo rate by 50 basis points (bps) to 5.9 per cent — which is largely on expected lines — as inflation continues to stay above 6 per cent, the upper level of its tolerance band, for the past eight months.
Except External Member Ashima Goyal, who voted for a 35-basis point hike, the rest were in favour of what the MPC settled for. Since May this year, the repo rate has been increased by 190 bps to 5.9 per cent, a three-year high.
The committee also decided to remain focused on withdrawing “accommodation”, which was supported by all except External Member Jayanth Varma.
While the policy statement was seen as dovish, RBI Governor Shaktikanta Das alluded to a third major shock — the other two being the pandemic and Russia-Ukraine war — which is aggressive monetary policy actions by developed economies.
“The world is in the eye of a new storm … The recent sharp rate hikes and forward guidance about further big rate hikes have caused tightening of financial conditions, extreme volatility and risk aversion … There is nervousness in financial markets with potential consequences for the real economy and financial stability,” Das said, adding that despite this unsettling global environment, the Indian economy continued to be resilient.
The RBI sees the inflation rate falling to 5 per cent during the first quarter next fiscal year.
Terminal rate
Some market participants were expecting a change in stance to “neutral”. Commenting on the stance, Das highlighted when the stance was changed from “neutral” to “accommodative” in June 2019, liquidity was in deficit and the inflation rate was trailing the repo rate. The situation is the opposite now as shown by the fact that real rates are negative and liquidity is still in surplus, though the magnitude has come down.
In the post-policy press conference, Das, however, abstained from commenting on under what circumstances the committee would change its stance.
“The central bank did little to remove the ambiguity and perceived deviation around its stance, keeping it unchanged at ‘withdrawal of accommodation’, contrary to our expectations that a move to neutral was on the cards,” HDFC Bank said in a note.
Nomura raised its terminal rate to 6.50 per cent (from 6.15 per cent earlier).
Soumya Kanti Ghosh, group chief economic adviser, State Bank of India, said in a note: “We believe that a 35-bps rate hike in December looks imminent but beyond December it would be a touch and go.”
Lower than expected GDP growth in April-June prompted the RBI to revise the growth forecast for FY23 to 7 per cent from 7.2 per cent. However, the FY23 inflation forecast of 6.7 per cent was retained despite a sharp drop in international crude oil prices.
FX reserves
There was some criticism regarding the use of foreign reserves to defend the rupee.
Das, however, said about 67 per cent of the decline in reserves this fiscal year was due to valuation changes arising from an appreciating US dollar and higher US bond yields while adding there was an accretion of $4.6 billion to the reserves through balance of payments (BOP) during Q1 of 2022-23. He said the RBI did not target any particular exchange rate.
Liquidity to return
While liquidity in the banking system turned to deficit on some days in September, Das said the situation would improve as government spending started and the impact of advance tax faded.
Expected loss model
The banking regulator said a discussion paper would be floated on the expected loss-based approach for loan loss provisioning by banks. At present, commercial banks follow an incurred loss model for non-performing asset provisioning, though non-banking financial companies have moved to the expected loss model. Such a step will increase banks’ capital requirement.
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