Why Repo rate may be unchanged

Why MPC  may decide to pause Repo Rate

The Monetary Policy Committee (MPC) of Reserve Bank of India (RBI) is meeting in Mumbai from 4th to 5th October 2023 to review the policy (Repo) rate and its monetary stance.  Whether the decision will be a reduction or an increase or no change? I attempted an answer:

1. Why MPC may not cut the present Repo Rate of 6.5% 

(i) FED fund rate has been unchanged, but the statement that followed after the meeting, indicated that there may be one upward rate revision in 2023 and possibly two upwards in 2024. 

(ii) With a cut in crude oil supply by Saudi Arabia and Russia continuing up to Dec 23, the crude oil price has hardened once again and touched USD 90 per barrel last week

(iii) Though the retail inflation has come down by 61 bps in Aug 23 as compared to July 23, the levels at 6.83% is much above the upper band of the inflation target range of 2%-6% and is the second highest CPI inflation reported in 2023 (peak was 7.44% in July 23)

(iv) With fluctuating monsoon rains through out the first half of FY 2023, food prices are likely to rule higher for some more time. 

(v) Decision to withdraw Rs.2000 notes from the money circulation (which were not observed to be in use by public for their transactions) has brought in money of Rs.3.42 lac cr. into the hands of the public and the banking system. RBI also withdrew its decision to impose an incremental CRR (ICRR), which was announced along with its policy statement in August 2023. The impounded money on account of ICRR will be fully released by 7th October 2023. Banks' credit growth continues unabated (with the increase in DTL) and more concentrated growth happens in consumer loans particularly in unsecured and gold loan portfolios, where no productive assets are created. Incidentally, 'Monetary Theory and Practice Text Book' says credit growth always multiplies money in circulation and fuels inflation.

2.Still MPC may not increase the repo rate: 

(a) Forex Reserves, on the decline in the last few weeks, is still comfortable at USD 590.7 billion, adequate to cover 8-9 months imports requirements

(b) The elevated crude oil prices may not get passed on to the Indian consumers immediately, as the major oil companies did not pass on the reduction in crude oil prices to consumers since last year, though the prices declined considerably since last year (prior to the present increase). With that logic and national elections around the corner, the government may succeed in convincing the major oil companies for no increase in fuel prices.

(c) CAD continues to be low at just 1.1% of GDP in Q1FY24 (2.1% in Q1FY 23)

(d) With indirect and direct tax collections meeting the budget estimates so far, the fiscal deficit target of 5.9% is likely to be achieved. Hence, the government borrowings are likely to be within budgeted levels. 

(e) The effect of transmission of increased repo rates into lending rates is still on and not complete. 

So in all likelihood, MPC may continue to decide to keep the repo rate unchanged.

Regarding the monetary stance, JP Morgan has announced its decision to include the eligible India Government Bonds into its widely tracked GBI - EM index, effective June 24. Economic and financial experts in the market are predicting that the yield of the bench mark 10- year G-sec may trade in the range of 6.75-7% by March 2024. So it is likely that the banks with excess SLR may off load the G-secs in their books for profit as well as to divert the money received towards credit growth. If MPC would like to align the repo rate to the target level of 4% by keeping the monetary stance of "Remaining focused on withdrawal of accommodation to ensure that inflation progressively aligns with the target, while supporting growth", then RBI, which holds the tools for achieving monetary stance, should demonstrate its will by increasing the SLR at least by 50 bps. This will help in neutralizing any excess money supply towards loan, by sale of excess SLR securities by the banks.

Regards

V. Viswanathan

3rd October 2023