By Sachchidanand Shukla
The consensus view was that the April meeting of the MPC will be its toughest since the Covid outbreak and hence it would continue in the same vein as its February policy. But the RBI managed to surprise the consensus again by normalizing its policy corridor even as it continued on the path of withdrawal of accommodation by stealth despite a notable change in its macro outlook.
The RBI’s downward revision of the domestic growth forecast to 7.2% (vs 7.8% earlier) was stark with two key changes in assumption. Crude oil prices are now estimated at $100/ bbl vs $75 earlier and global growth expectation being lower at 3.5% vs 4.9% earlier highlighting that the deterioration in the global backdrop posed greater challenges to India’s growth outlook. The RBI also revised its inflation forecast upward by a huge 150 basis points to 5.7%. But the RBI ‘normalized’ its policy corridor and announced the withdrawal of accommodation by introducing the standing deposit facility (SDF) at 3.75%, in between the reverse repo (3.35%) and the Repo (4%) thereby strengthening the operating framework of monetary policy. The implementation of the Standing Deposit Facility (SDF) as the new floor of the LAF corridor will not only provide discretionary choices to banks to park excess liquidity, but it will also solve the issue of the limited supply of G-secs while parking liquidity with RBI. Unlike reverse repo, SDF is a collateral-free instrument and RBI doesn’t require to provide G-secs as collateral to the banks. The normalisation of the LAF was well telegraphed to the market as RBI has been absorbing liquidity closer to the repo rate since October last year. Moreover, in a bid to support recovery where output has barely cross not so flattering pre-pandemic levels, the RBI has focussed on gradualism by taking a multiyear approach to mop up the build-up of excess liquidity.
Moreover, the RBI being the investment banker for the government, took steps to ensure smooth management of the humongous borrowing plan for this fiscal year. Note Interest payments for FY23BE is ~23.8% of expenditure and ~41.2% of non-debt receipts. Assuming the weighted average borrowing cost of government at 6.3%, the same as in FY22, even a 50 bps rise in average borrowing costs raises interest payments by ~ INR 70 bn at a time when there are competing demands for govt spending.
The government plans to frontload almost 60% of the Rs 14.3 tn borrowing in the first half to fund its capex plans. To keep the borrowing costs low, the RBI has extended the HTM limit from 22% to 23% till March 2023. The extension of the HTM limit will help banks to absorb the huge supply of G-secs and shield banks from a mark to market hit. Given the rise in yields, a mark to market of securities would have eroded the value of treasury portfolio of banks and impede their ability to dispense credit.
The RBI’s communication has been very effective unlike some other large central banks. It maintained the commitment to nurturing growth and emphasized the use of the word ‘orderly’ quite a few times. Note, the output gap remains large and personal consumption is still below pre-pandemic levels.
To anchor inflation expectations, it is important that the RBI continued to communicate how it will react to inflation and other economic data, including movements in inflation expectations, and signal its readiness to respond rapidly to any significant change in the medium-term inflation outlook.
Going forward, given that the RBI’s revision of its FY23 CPI forecast is within the upper band of 6%, it may be well justified in deciding to stay the course on rates even as it normalized the corridor. However, given the extreme geopolitical volatility, all estimates will have to contend with large forecast errors. Hence, in case risks to growth do not spike and the inflation outlook worsens, the RBI will be in a better position to effect a change in its policy stance in the forthcoming meetings.
The writer is group chief economist, Mahindra Group. Views are personal. With inputs from Sarbartho Mukherjee, economist, M&M.
