Repo rate: Change or No change

 REPO RATE: ‘PAUSE’ or ‘CHANGE’?

As MPC (Monetary Policy Committee) of RBI (Reserve Bank of India) meets to-day to review the regulator’s policy rate, all eyes and ears, linked to finance in some way, are tuned to the ground to listen to the statement of RBI Governor at 10.00 a.m. on Thursday, the 6th April 2023. Will it be an increase in the rate for the 7^th time in a row or a ‘pause’ to breathe normally for some time? (Factors that may influence the repo rate is given in Annexure)

MPC in a dilemma:
MPC has a mandate to keep the inflation at 4% with a lower and upper tolerance level of 2%.  The committee has an obligation to explain to the Parliament, if the actual inflation is not within the target level of 2-6% for three consecutive quarters. The average inflation in the last quarter was above the upper band of 6% and is likely to be so in the quarter ended Jan-Mar 23 as well. So, if the inflation breaches the 6% level for April-June 23, MPC has to face the Parliament once again, as the breach will be for three consecutive quarters.

Choices before MPC:
Repo Rate: Play safe and increase the rate by 25 bps or press the ‘pause’ button for the time being. As the inflation is likely to be above 5% throughout 2023-24, MPC may also seek a review in the target rate for the next two years with an understanding that the current target rate can be restored by March 2025.
Stance: Continue the same stance as CPI inflation is much above the intended target of 4%

My views:

1. Increase may impact only loans linked to external benchmark rates: There used to be ‘slack season’ and ‘busy season’ credit policies from RBI corresponding to April- September and Oct-March periods. Though such policies are done away with now, it is a fact that no fresh arrivals of crops are witnessed in Q1 of a financial year and business also usually returns the funds availed from the market in the first quarter.  Banks also report negative/tepid growth in loans in the first quarter. (This is one of the reasons for the government borrowings to be higher in the first half of any financial year). Hence, there may not be any increase in deposit rates, as the banks are not in need of money for lending/investing, which activities will be funded from the credits/repayments into the loan accounts. Banks may not even increase their internal bench mark rates linked to other loans, as the customer may reduce his drawings, in view of the increase in interest costs. Hence, if the repo rate is increased, interest rate increase may happen only in loans linked to repo rate (by the same percentage point). And that include loans to MSMEs, which act as an anchor to the growth of the Indian economy.

2. A pause may help in improving business sentiments and also stabilise the money market rates: The yields in the short term money market instruments are quite high. A pause may restore price stability especially in the treasury bills and certificate of deposits. Indicating a ‘pause’ at the start of a financial year, after six continuous increases (aggregating 250 bps), will help in conveying that the monetary policy actions to control inflation are not aimed at dampening the growth sentiments. Stability in G-Sec yield, may also help the government to price its borrowings accordingly.

Regards

V.Viswanathan
3^rd April 2023

Annexure FACTORS THAT MAY INFLUNCE REPO RATES External Factors - Common ·   FOMC increased the fund rate again by 25 bps. Its statement that the year-end projected fund rate is likely to be higher than the current rate, indicated that there may be an increase of at least 25 bps in one of its future meetings.   ·     Central Banks of UK, Australia and Canada increased their policy rates by 25 bps, while ECB continued the 50 bps increase in the latest round also ·     Some countries continue their policy stance of being accommodative, the notable ones being China and Japan (no change in their policy rates for quite some time) ·      Inflation in all countries softened but are still at much higher levels compared to the target levels fixed by the regulators ·      Collapse of SVB, Credit Suisse and few other banks in US created concerns in the minds of central banks on continuing with further tightening of policy rates.   External Factors – exclusive for India ·     Crude Oil averages between USD 80 and USD 85 per barrel, at least 15% less than the assumption made by RBI (USD 100) in arriving at inflation projections for FY 2023-24. ·      FEX reserves at USD 573 billion (17th March 2023) is comfortable and covers more than 9 months imports. ·       FPI inflows turned positive after three months, though fund rate continue to go up in between. ·    NRI Remittances and earnings from exports by Services sector continues to be impressive and the current account deficit had come down in the quarter ended Dec 2022, as compared to the corresponding quarter of the previous year.   Internal Factors – Ø CPI inflation came down to 6.44% in Feb 23 (6.52% in Jan 23), though core inflation continue to rule higher at 6.2% Ø  There are no signs of any slowdown in growth. Indian Growth is stronger with no issues on the supply side from agriculture, industry not showing any signs of contraction and services maintaining its momentum. Ø Loans linked to repo rates have gone up by 250 bps, loans linked to internal benchmark rates like MCLR have gone up by 135 bps and the average deposit rates have gone up by 82 bps, though the rates have gone upto 150 bps in some select tenors with almost all the banks.