Will it be 'pause' in repo rate this time?

Repo Rate: Will it be a ' Pause' this time? 

Monetary Policy Committee (MPC) of Reserve Bank of India (RBI) starts its three day meeting to-day. The governor of RBI will announce its decision along with his statement on 7th December 2022.  Experts in the financial field and otherwise are expecting an increase this time also, with slight variations in their projections..  However, I find near unanimity in their expectations that this time RBI may not frontload the increase by 50 bps, as had been the outcome in the last three MPC meetings. They expect the increase to be in the range of  25-35 basis points (bps). (No one knows whether RBI may bring a surprise to them on this score!)

As a layman, I put forth my view that as inflation is tampering down from its peak level, (but still above the upper band of +2% over 4%, targeted by RBI), the impact of repo rate increase on the economy is likely to be felt in the coming months, the MPC may very well decide to keep the repo rate unchanged in their current meeting. My arguments are based on the following positive factors

1.   Crude Oil (Indian Basket): In its monetary policy report, released on 30^th Sep' 22 along with the Governor’s statement on MPC decision bearing the same date, RBI had stated that inflation could ease by around 30 bps and growth will receive a boost of 20 bps, if the Indian basket of crude oil prices falls by 10% relative to its baseline assumption of USD 100 (per barrel). The average crude oil prices for Nov’ 22 was USD 91. After ruling around USD 100 level between Mar’ 22 and Sep’ 22, the crude oil prices declined and averaged USD 90 in the last three months. JP Morgan has predicted that the average international crude oil prices for 2023 at USD 90. Hence the crude oil prices (Indian basket) are ruling at a level, less than 10% of the baseline assumption made by RBI in its above report.

2.   Exchange Rate: The above report, for inflation projections, assumed the exchange rate of INR vs. USD at Rs.80/1 USD. It also stated that every deprecation of 5 per cent in the rupee, over the baseline assumption, could result in inflation edging up by 20 bps and growth coming down by 10 bps. Indian Rupee, which ruled in the range of Rs.82.5 to Rs.83 per USD, has since dropped down and was around Rs.81.5 for the whole of Nov’ 22. With reduction in crude oil prices since Sep’ 22, which is likely to continue around USD 90 level in 2023 as well, the pressure on the rupee is likely to reduce. In recent months, export of crude oil from Russia has gone up substantially. Added to that is the government’s efforts to persuade Russia to make its major banks to open Vostro accounts in India. So, the chances of Indian Rupee ruling around the baseline assumption of RBI  looks bright.

3.     CPI Inflation: As per data released for Oct’ 22, CPI inflation and food inflation have declined from 7.4 % and 8.6% in Sep' 22 respectively to 6.77% and 7.01% in Oct' 22. The monetary policy report of RBI says with factors like

-         kharif sowing  maintained at its long term average,

-         higher reservoir levels (due to copious rains) auguring well for rabi crop and

-         availability of ample buffer stocks coupled with effective supply management,

          food inflation could soften more than anticipated levels and push the headline                        inflation  by 50 bps below the baseline.

 

4.  Tax Revenues: Gross Tax Revenues (GTR) have grown by 18% in the first seven months of the current fiscal, as against 10.7% growth achieved in the last FY. If the same trend in growth is continued, GTR is expected to be up by Rs.4.4 lac Cr.  for 2022-23. GST collections have crossed Rs.1.40 lac Cr. for the ninth month in a row and the collections in this front for the current fiscal is at Rs.11.91 lac Cr. as against a collection of Rs.9.36 lac Cr. during the corresponding period last year. Actual revenues from GST for the current fiscal are likely to be much in excess of budget estimates of Rs.14.4 lac Cr. (Centre and States combined) as 83% of total budget is already received up to Nov’ 22 (four months still remaining). Hence the government should be able to contain the fiscal deficit (6.4%) within the budgeted level. (Auguring well for no increase in inflation on this score)

5.   Effect of Repo Rate transmission by bankers: The increase in repo rate had already been transmitted in full by the bankers to the borrowers enjoying loan facilities, which are linked to repo rates. In this regard, the percentage of loans that are linked to repo rates moved up from 29.5% in Mar’ 21 to 46.9% of the floating rate loans in June 22. Hence the increase in repo rate by 190 bps is already passed on to nearly 50% of the bank borrowers, the impact of which is likely to be felt in the last quarter of FY 23. 

6.     Liquidity: The increase in CRR by 50 bps and OMO sales in the early part of 2022 combined with an average bank credit growth of 12-15% (yoy) has already wiped out the entire liquidity in the financial system. (It also ensured that the liquidity induced inflation conditions are removed from the economy). With the prices of dated G-Sec., not at levels attractive enough for disinvesting the surplus SLR, interest rates of certificate of deposits ruling higher (reflecting the price of money market instruments), commercial banks have raised their retail deposit rates by nearly 100 bps in the last two months. Some of the major commercial banks offer interest rates even above 7.25% in select buckets. To compensate themselves for the increase in cost of deposits, the bankers have raised the interest rates on loans, which are linked to internal bench mark rates like MCLR (46.% of total floating rate loans), Base Rate etc. Hence transmission of repo rate is not confined to loans that are linked to repo rates only. 

(Repo rate transmission across all bank loans so far and the near zero liquidity in the financial system will have their positive and negative impacts on inflation and growth respectively)

7.   Forex Reserves: Forex reserves, which declined to USD 524 bn. in Oct' 22 (from the peak level of USD 642 bn. on 5^th Nov’ 11), is on the up-curve again. It has gone up by USD 26 bn. in the last three weeks and was at USD 550 bn. on  25 Nov' 22. The increase has happened despite the fact that FED increased its fund interest rates by 75 basis points on 2 Nov' 22.

 

Uncertainties: Of course, there still exists, issues of concern from the external front like, 

(i)          The impact of FED rates ruling now at 3.75%-4% on foreign currency investments into India, necessitating an increase in repo rates and

(ii)         Uncertainties in world trade on account of the continuing Russia-Ukraine War with no signs of end in sight. 

Conclusion: Though there are enough positive factors to call for a ‘pause’ in repo rates this time, the MPC may still feel that due to the increase in FED rates and continued global uncertainties on account of the on-going Russia-Ukraine War, 'no change' decision in repo rate may convey unnecessary optimism in the market, not conducive to achievement of containing the inflation within the target level. But the MPC should keep in mind that the economy, which has not yet slowed down, should move forward to achieve the GDP forecast growth of 7%. So I would suggest that the increase in repo rate, if at all, should be only marginal, say 10 bps (from  5.90% to 6.0%). This will help to convey that the positives in the economy are taken into account and the increase is still warranted on account of existing external uncertainties.

 

Regards

 

V.Viswanathan

5^th December 2022   

 

 

 

 

 

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