Rate hike continues; commentary still not dovish

Highlights

Repo rate hiked by 35 bps to 6.25%

CRR unchanged at 4.5%

The RBI MPC was of the view that further calibrated monetary policy action is warranted to keep inflation expectations anchored, break core inflation persistence and contain second round effects. These actions are expected to strengthen the medium-term growth prospects of the Indian economy. Accordingly, the MPC decided to increase the policy repo rate by 35 basis points to 6.25% and remain focused on withdrawal of accommodation, while supporting growth. Consequently, the standing deposit facility (SDF) rate stands adjusted to 6.00% with the marginal standing facility (MSF) rate and the bank rate at 6.50%.

Over the next 12 months, inflation is expected to remain higher than the 4% target. System liquidity remains in surplus with average daily absorption under the liquidity adjustment facility (LAF) of | 1.6 lakh crore in November 2022. Since then, it has gone up to | 2.6 lakh crore as on December 5. The overall monetary and liquidity conditions remain accommodative.

Inflation is projected at 6.7% in 2022-23, with Q3 at 6.6% and Q4 at 5.9%, and risks evenly balanced. CPI inflation for Q1: 2023-24 is projected at 5.0% and for Q2 at 5.4%, on the assumption of a normal monsoon.

Real GDP growth for 2022-23 is projected at 6.8%(from 7%), with Q3 at 4.4% and Q4 at 4.2%. The risks are evenly balanced. Real GDP growth is projected at 7.1% for Q1: 2023-24 and at 5.9% for Q2. Even after this revision in our growth projection for 2022-23, India will still be among the fastest growing major economies in the world.

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The initial bond market reaction to the policy meeting outcome was marginally negative with benchmark 10-year yield moving up around 5 bps to 7.30% from 7.25%. Short term yields moved up around 5-10 bps.

While the hike was largely on expected lines, the debt market was expecting the commentary to be dovish with some guidance on the terminal repo rate. The market was pricing in the terminal repo rate at 6.5%, implying a cumulative rate hike of 60 bps in two meeting. Effectively, since just one last hike of 25 bps is priced in, a dovish commentary with some guidance on the terminal repo rate was expected. Also, in the last two weeks, the 10-year G-Sec yield had moved down around 5 bps post dovish comments by US Federal Reserve Chair Jerome Powell and in anticipation of a lower hike by the Fed.

Overall, the interest rate cycle is nearing its end. With H1FY24 CPI projected at 5.2%, repo rate at 6.5% offers real rate of 1.25%, which falls under RBI’s target range of 1-2%. Rate hike and future guidance by the Fed in its December 14 meeting will be the key driver for both debt as well as equity markets in the near term.

After almost two years, the debt market outlook has started to look attractive with rate hikes being already done or discounted. Investors may start building their long term fixed income portfolio gradually starting with allocation into medium (two to five years) maturity funds like short-term debt funds or medium term debt funds. Duration funds may remain volatile in the near term just like the last few days on the back of a sharp movement in longer duration yields.

RBI development, regulatory measures – Key points

SLR holdings in HTM category – extension provided

RBI had increased the limits under held to maturity (HTM) category from 19.5% to 23% of net demand and time liabilities (NDTL) with respect to statutory liquidity ratio (SLR) eligible securities acquired on or after September 1, 2020, up to March 31, 2023. This dispensation of enhancement in HTM limit was made available up to March 31, 2023. With a view to enable banks to better manage their investment portfolios, it has been decided to extend the dispensation of enhanced HTM limit of 23% up to March 31, 2024 and allow banks to include securities acquired between September 1, 2020 and March 31, 2024 in the enhanced HTM limit. The HTM limits would be restored from 23% to 19.5% in a phased manner starting from the quarter ending June 30, 2024.

The next meeting of the MPC is scheduled for February 6-8, 2023.

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