Will US banking crisis cast shadow over RBI’s first MPC of FY24? Key indicators to watch

RBI is expected to raise the key repo rate, the rate at which it lends money to banks, by 25 basis points (bps) to a seven-year high of 6.75 percent

Reserve Bank of India (RBI) Governor Shaktikanta Das will unveil the first monetary policy of the new financial year on April 6 after a two-day review amid a banking crisis in the United States and inflation concerns that threaten the pace of economic growth.

As the banking sector weighs on central bankers, the RBI, too, has its work cut out. The bi-monthly policy review by the six-member Monetary Policy Committee (MPC) led by Das will indicate the course the central bank will take in the financial year 2023-24, as it seeks to strengthen medium-term growth and curb inflation while battling global headwinds.

The US Federal Reserve moderated its hawkish stance after the shock collapse of the Silicon Valley Bank (SVB) sent ripples through the country's banking system. Across the Atlantic, UBS' takeover of Credit Suisse hardly helped.

The goings-on in the banking industry also signals uncertainty for India’s growth even as high inflation continues to be a challenge. High food prices and weather-related shocks are some of the domestic triggers that can influence MPC’s decisions.

The heatwave in February followed by unseasonal rains in March is expected to affect crops in the north. Persistent banking problems in the US can lead to deprecation in the rupee on worsening of the risk sentiment and a tightening of monetary policy.

The Russia-Ukraine war, which has had a bearing on macroeconomic conditions in India, like elsewhere, is in its second year. The spill-over effect of the conflict that led to a dramatic rise in prices of crude and food continues to be felt.

What lies ahead 

The RBI is expected to raise the key repo rate, the rate at which it lends money to banks, by 25 basis points (bps) to a seven-year high of 6.75 percent before leaving it at that level for the rest of the year, economists who participated in a poll conducted by news agency Reuters said.

If realised, it will mark a cumulative 275 basis point increase since May 2022, a relatively modest rate cycle compared with some other central banks like the Fed, Reuters said. One bps is one-hundredth of a percentage point.

Economists are divided on whether the RBI should change its stance to "neutral" or persist with "withdrawal of accommodation". Broadly, experts agree that the US banking crisis and the evolving global scenario will dictate the RBI’s stance.

Also Read: Retail inflation cools off to 6.44% in Feb on softening food prices

Here are the key indicators to watch out for during the MPC:

Inflation

Inflation in Asia's third-largest economy remains above the central bank's upper tolerance limit of 6 percent, reaching 6.52 percent in January and easing only slightly to 6.44 percent in February — a key reason for the RBI to hike interest rates again. Retail inflation has stayed above the RBI’s medium-term target of 4 percent for 41 months in a row now.

"Crude oil going up and down is unlikely to make any meaning to RBI’s inflation trajectory. Unless the government cuts fuel prices, but that is not going to happen. If that doesn’t happen, core inflation is unlikely to decline meaningfully to below 5.5 percent by the year-end and we may have to see several rate hikes, and not just one in this policy," Soumya Kanti Ghosh, Group Chief Economic Advisor at State Bank of India (SBI), told CNBC-TV18.

“Inflation has not reacted to the monetary policy that has been carried out for the last two years," former chief statistician Pronab Sen has said.

Assessing the inflation scenario, Sonal Varma, managing director and chief economist at the Japanese securities house Nomura Financial Advisory, said it was high time the “RBI policy becomes forward-looking".

"The forward-looking inflation trajectory is looking softer, commodity prices are down, and the global growth outlook is looking weaker. Domestic lead indicators are pointing towards a slowdown in demand. We know that the monetary policy works with a lag, so the decision today cannot be based on yesterday’s data," Varma told CNBC-TV18.

Also Read: Global slowdown hits India, Nomura sees poor growth for next 2 years

Change of stance?

In a recent report, the country’s largest lender State Bank of India said that the RBI’s stance in the April meeting could continue to be “withdrawal of accommodation” and it can always keep the options open for the June policy.

"RBI will have a delicate balancing job of either looking forward to the June meeting with clear signs of inflation trending downwards or looking backwards at the Jan and Feb prints in the April policy. Thus, it will be a delicate choice," SBI said in its research report.

Sajjid Chinoy, Chief India Economist at JP Morgan, also said the RBI had done over almost 300 bps of the hike. So at some point, it would have to stop and wait for the previous hikes to filter through, he said.

"Going forward, the RBI will become data-dependent. I expect the existing stance with certain tweaks. A switch to neutral would in a way offset the rate hike itself in terms of the impact it has on bond yields," Chinoy told CNBC-TV18.

Samiran Chakraborty, India chief economist at Citibank, foresees a change of stance to “neutral”

"All of the accommodation that the RBI provided during the pandemic – whether it is on the rates front, or whether it is on the liquidity front, has now been withdrawn. The neutral stance gives greater flexibility and does not restrict new rate hikes. So, if there is a requirement for a rate hike, the RBI can still do it," Chakraborty told CNBC-TV18.

Also Read: RBI to conduct 5-day Variable Rate Repo auction on March 24

Liquidity

In March, the RBI announced that it conducted a five-day Variable Rate Repo (VRR) auction for a notified amount of Rs 75,000 crore after a review of current and evolving liquidity conditions.

The variable rate repo auction is done to inject liquidity into the banking system when it turns negative or is in deficit. The liquidity in the banking system is estimated to be in a deficit of around Rs 76,513.68 crore.

Brokerage firm Kotak Institutional Equities anticipates a 25 bps hike in the upcoming policy followed by a cash reserve ratio (CRR) cut of 50 bps in mid-FY24 to ease liquidity.

"When the fresh supply of government bonds hits the market in April-May, but if for some there is not enough demand for it and yields start spiking up, the RBI can start doing some liquidity infusion operations through OMO to avoid any contagion effect, if the stance is neutral. From a withdrawal of accommodation stance, doing that will be very difficult," said Citibank’s Chakraborty. OMO is short for Open Market Operation.

Also Read: RBI MPC: FY24 GDP growth seen at 6.4%, says Governor Shaktikanta Das

Growth

In the February MPC meeting, the rate-setting panel pegged the gross domestic product (GDP) growth for FY24 at 6.4 percent. “Economic activity in India remains resilient, while investment activity continues to gain traction, and rural demand continues to show signs of improvement,” Governor Das said while announcing the MPC outcome.

Chakraborty said as far as the global growth picture was concerned, the January-March quarter growth was much higher than anticipated. ‘’Because of high uncertainty, central bankers across the world are taking a view that they will pick up the pieces if something breaks rather than taking a view that they will act before it breaks,’’ said Chakraborty. “So going forward, the monetary policy is going to be more reactive, rather than proactive. We expect the RBI to follow the same pattern.”

Nomura anticipates a slowdown in growth in FY24, with chances of further downside in the following year. The firm said weaker momentum in domestic demand for private consumption as well as fixed investment.

‘’The good scenario would be that the policy responses done so far curtail any increase in financial stress which is our current baseline, but there is a risk that as rates stay higher for a longer period of time and growth slows down, we see more financial risk evolve.

“Even in such a case, it is likely that banks are going to tighten their lending standards. Broadly, lending standards which were already being tightened even before SVB crisis happened, will be tightened further,’’ said Nomura’s Varma.

Also Read: Does RBI have a case for pause in April?

Overview

In February, the MPC raised the repo rate by 25 bps, taking it to 6.5 percent. Since May 2022, it has hiked rates by 250 bps. While hiking the rate, the RBI reaffirmed its commitment to fight inflation but indicated that the nascent economic recovery needed policy support.

With fears of a global recession raging, in India, too, there are escalating concerns on the growth front. India is expected to grow slower at 6.1 percent in 2023, compared with 6.8 percent in 2022, according to the International Monetary Fund.

The RBI is mandated to keep the inflation rate at 4 percent (+,- 2 percent). As inflation continues to be a worry, some experts reckon that a modest 25 bps hike on April 6 will be the last of the current cycle.

Several others, however, feel that there is a residual expectation of one more Fed rate hike in May and until that is behind, the RBI may not be very comfortable in signalling that it is done with the hikes.​