Repo rate, India's benchmark policy rate, is moving forward while staying at the same place, for now.
With the RBI's Monetary Policy Committee (MPC) unanimously deciding to maintain status quo, the key policy rate squats at 6.5%, while the marginal standing facility and bank rate are moored at 6.75%.
This is the third consecutive policy review that saw RBI standing pat on rates, as well as on the stance, which remains unchanged at 'withdrawal of accommodation.'
This is precisely what markets expected, but given the upward revision of FY24 inflation forecasts, markets launched into a ‘higher for longer’ interest rate narrative, as equities, bonds and currency markets sulked in protest.
Blame it all on tomatoes.
The humble kitchen staple not only unleashed untold grief on households, but also unsettled monetary policymakers. With prices splashing red on headline inflation, FY24 forecasts were revised upwards by 30 bps from 5.1% projected in June to 5.4% now.
RBI's CPI estimates for are pegged at 6.2% for Q2, 5.7% for Q3, and 5.2% for Q4.
Confirming some more fears, Governor Shaktikanta Das indicated that the trend of rising prices will likely spill over to next fiscal, as he pegged FY25 Q1 at 5.2%, 120 bps higher than the targeted 4%.
As for the current quarter, Das noted that both July and August inflation may see higher-than-projected inflation prints, solely due to rising vegetable price shocks.
Das acknowledged that the recurring food price shocks were a risk to anchoring inflation expectations and called for timely supply-side interventions, given the likely short-term nature of vegetable prices. However, the MPC is willing to look through the tomato-turbulence.
Metaphorically, this could be RBI's hardest phase, or what Oscar Wilde described as 'awfully hard work doing nothing' and yet expecting inflation to yield and dutifully give in to the 4% mandate.
But it was Das's additional remarks on inflation, and going beyond merely keeping an Arjuna's eye -- perhaps hinting at a rate hike if warranted -- that likely irked markets more. Das said it was "necessary to be watchful of the emerging trends and risks to price stability...stand in readiness to go beyond keeping Arjuna's eye to deploying policy instruments, if necessary."
Until now, two key questions were weighing on the markets mind: How long will the RBI continue to pause, and, when will rate cuts begin? Following Thursday's policy statement, the biggest fear is that rate hikes may be lurking around the corner, given elevated food and crude oil prices.
Earlier, the dominant view was that, at 6.5%, the policy rate has peaked, and unless inflation deviates from the projected 5.1% target for FY24, no further rate hikes were on the horizon. That has changed on Thursday, with CPI forecasts revised upwards to 5.4% and with Das explicitly reminding about the ultimate weapon: 'deploying policy instruments, if necessary.'
As for a rate pause, as Das has been repeatedly emphasizing, the MPC will remain on the warpath until it sees a durable decline in price rise, which is likely next fiscal year. Headline CPI is expected to fall to the 4% band only during the latter half of calendar year 2024.
Das reiterated: "Bringing headline inflation within the tolerance band is not enough; we need to remain firmly focused on aligning inflation to the target of 4%." This is where the narrative is more hawkish than market expectations, and there is also a bias to hike further. Effectively, the possibility of a rate cut has gone out of the 2023 window.
Lastly, in some good news for retail borrowers, Das proposed a transparent framework to reset floating interest rates on loans, mandating lenders to communicate tenors or EMIs to consumers, provide options for foreclosure or fixed rates, and others. It's expected to strengthen consumer protection.
Among other highlights, scheduled banks have been ordered to maintain an incremental cash reserve ratio of 10% on the increase in their net demand and time liabilities between May, 19 and July, 28. The move, an entirely temporary measure, is aimed at absorbing the surplus liquidity from the system, particularly from the withdrawal of the 2000-rupee note.
Reading out the report card on India's supply and demand-side indicators, Das concluded that the overall momentum is good.
On the supply-side, crop production and industrial activity were holding ground, while buoyant services activity in the form of e-way bills, toll collections, and jump in services PMI indicated resilience.
Aggregate demand in urban and rural areas remains a mixed bag.
While the sales of commercial vehicles fell, other urban demand indicators like air traffic numbers and passenger vehicle sales painted an optimistic picture.
Similarly, even as two wheeler sales moderated in rural areas, tractor sales held ground.
As for investment, government expenditure is holding up well, while construction activity remains strong in Q1, with rising cement production and steel consumption. Capacity utilization too is at respectable 76.3%.
So FY24 real GDP growth estimates remain unchanged at 6.5%, with Q1 at 8%, Q2 at 6.5%, Q3 at 6%, and Q4 at 5.7%. For FY25, real GDP growth rate for Q1 is pegged at 6.6%, with risks evenly balanced.
Meanwhile, monetary policy divergence among countries continues, with central banks in advanced economies continuing rate hikes, while emerging market central banks are opting for a pause or rate cut.
The US Federal Reserve, the European Central Bank and Bank of England raised rates by 25 bps last month. Although the outlook of the US economy remains resilient, the jury is still out on whether there will be a soft landing.
While RBI has maintained that its decisions are based on domestic inflation and growth considerations, the fact that global central banks may be less aggressive in future rate hikes should work in favour of RBI by keeping rates on pause at least for some time.
Giving additional comfort, the Indian bond market volatility has been in a manageable zone over the past few months and significant movements in US treasury yields were no longer influencing Indian yields to the extent they did last year, SBI Research noted.