RBI Keeps Repo Rate Unchanged at 6.5% Amidst Inflation Woes

In a highly anticipated move, Reserve Bank of India (RBI) Governor Shaktikanta Das unveiled the third bi-monthly monetary policy for the fiscal year 2024 on August 10th. The announcement follows a three-day meeting of the six-member Monetary Policy Committee (MPC) of the RBI, held from August 8 to 10. Despite expectations of a rate hike, the RBI maintained a cautious stance on inflation, keeping the repo rate steady at 6.5%. This decision comes after a series of rate hikes totaling 250 basis points (bps) since May 2022, as the central bank attempts to rein in inflationary pressures.

Interest Rates Remain Unchanged

Underlining the RBI's commitment to maintaining the status quo, several key interest rates remained untouched. The standing deposit facility (SDF) rate was upheld at 6.25%, while the marginal standing facility (MSF) rate and Bank Rate remained steady at 6.75%. The cash reserve ratio (CRR) was retained at 4.5%, signifying the proportion of deposits banks are required to maintain with the RBI.

GDP Projections and Inflation Forecasts

The RBI's projection for real GDP growth in the fiscal year 2024 remained constant at 6.5%. However, there were differing forecasts for the upcoming quarters. For Q1FY24, GDP was projected to grow by 8%, followed by 6.5% in Q2FY24, 6% in Q3FY24, and 5.7% in Q4FY24. The growth trajectory was expected to continue into the next fiscal year, with a projected GDP growth of 6.6% in Q1FY25.

Amid concerns of rising inflation, the RBI revised its Consumer Price Index (CPI) inflation forecasts. The CPI inflation forecast for FY24 was adjusted to 5.4% from the previous 5.1%. Furthermore, inflation forecasts for Q2FY24, Q3FY24, and April-June 2024 were also raised to 6.2%, 5.7%, and 5.2% respectively. However, the CPI inflation forecast for Q4FY24 remained unchanged at 5.2%.

Liquidity Measures and Regulatory Changes

The RBI implemented a liquidity management measure, requiring all scheduled banks to maintain an incremental cash reserve ratio (I-CRR) of 10%. This directive applied to the increase in their net demand and time liabilities (NDTL) between May 19, 2023, and July 28, 2023. Additionally, the regulatory framework for Infrastructure Debt Funds (IDFs) underwent a revision. Notable changes included the withdrawal of the requirement for IDFs to have a sponsor, permission for IDFs to finance toll-operate-transfer (ToT) projects directly, and the option for IDFs to raise funds through external commercial borrowings (ECBs).

RBI's Response to Current Economic Trends

Suresh Khatanhar, MD and CEO of IDBI Bank, viewed the RBI's decision to maintain the repo rate as a reflection of the ongoing inflationary trends and the overall encouraging economic activity in India. He pointed out the RBI's commitment to aligning inflation with the 4% target, signalling favourable interest rate conditions.

Economist Achala Jethmalani from RBL Bank regarded the MPC's decision as a 'hawkish pause'. The revision in inflation forecasts suggested a 'higher for longer' theme, and the expectation was that the repo rate would remain at 6.5% as India's CPI inflation tapered off in the second half of FY24.

Market Reactions and Experts' Views

Following the announcement, the domestic equity market experienced fluctuations. While the Sensex and Nifty initially made gains in rate-sensitive sectors such as banking, automotive, and realty, the gains were short-lived as the RBI upheld its status quo stance on policy rates and stance.

Madhavi Arora, Lead Economist at Emkay Global Financial Services, analyzed the impact of the incremental cash reserve ratio (ICRR) measure. She estimated a temporary liquidity depletion of around ₹1.15 trillion, assuming an effective CRR of 14.5%. Arora predicted a mild hardening of money market rates for borrowers and a slight impact on banks' Net Interest Margins (NIMs).

Governor's Insights on Policy Decisions

Governor Shaktikanta Das emphasized that the decision to impose the incremental CRR was a strategic choice amongst available tools to manage liquidity overhang. He acknowledged that liquidity is a dynamic factor, and the RBI would continue fine-tuning its operations on both the repo and reverse repo fronts.

Furthermore, Das highlighted that private investment was gaining traction in key sectors like iron and steel, automobiles, petroleum, chemicals, and metals. He expressed optimism that this trend would extend to other sectors as favorable ground conditions persist.

In conclusion, the RBI's 'hawkish pass' in maintaining the repo rate reflects its measured approach to balance economic growth with the need to control inflation. As the global and domestic economic landscape continues to evolve, the central bank remains prepared to make nimble adjustments to its monetary policy measures.