The Reserve Bank of India (RBI) didn't give any indication of an early rate cut, leaving bond prices largely unchanged, but the central bank set off a massive rally in stocks when it upped its growth forecast for the current year from an already outlier 7% to 7.2%. Of course, signs that a confident Narendra Modi will lead the next government also fuelled buying in the share market.
Coming back to the policy, although the RBI-MPC kept the repo rate unchanged at 6.5% and the stance unchanged at “withdrawal of accommodation," the number of dissenting MPC members rose to 2 out of 6. External member Jayant Varma, who had voted for a rate cut in April as well, is now joined by Ashima Goyal.
Both want the repo rate cut to 6.25% and the stance changed to neutral. Some see this as pressure on the RBI to change at least its stance in August and cut the rate by October. However, we need to remember that the term of both these members, along with that of Shashanka Bhide, ends after the August policy. Also, the RBI governor has a casting vote even if three members vote for a cut, and hence the repo rate won't change unless the RBI wants it to.
So what does the RBI want? The RBI’s upgrade of growth can mean that there is no hurry to cut rates since the current rates are not harming or hindering growth. Also, the RBI governor insisted at several points during the reading of the statement and in the presser that he wants to see inflation aligning sustainably to the target of 4%.
The retention of the stance at: "withdrawal of accommodation was also justified as needed to “ensure anchoring of inflation expectations and fuller policy transmission.”
The governor even elaborated that CPI would fall below the target 4% in the July-September quarter, but it is expected to rise again above 4% for the rest of the year, thus giving the impression that even an October rate cut may be tough.
Economists are still divided between October policy, December policy and next year for the first cut. But their indecision is understandable. There are two vital data pieces still due. The government will present its full and final budget in July and till then the fiscal deficit picture is unclear. Even a minor rise in the deficit can raise fears of higher inflation.
Secondly, economists are waiting for another piece of data from the RBI—its estimate of the neutral rate and the potential growth of the Indian economy. The neutral rate is the real rate at which inflation is at target and growth is at potential. Now real rate is defined as the difference between the nominal interest rate, or repo rate and actual inflation.
Currently, with the repo rate at 6.5% and the CPI forecast at 4.5% for this year, the real rate works to 200 bps. The RBI used to work with a real rate of 200 bps as the neutral rate in 2013–2016 when it was working hard to force inflation down from near double digits towards the 4% target.
But a few years ago, after the COVID-19 weakness, a study in the RBI bulletin had placed the neutral rate at slightly less than 100 bps. With growth recovering sharply, will the RBI's neutral rate rise back to 200bps? That may be revealed in the RBI’s June bulletin, DG Michael Patra said.
If the neutral rate is pegged below 200 bps (at say 150–175 bps), the market will begin assuming a cut later this year. The expected article on the neutral rate will also give us the RBI's assumption of the economy's potential growth.
If RBI sees the potential of the economy at say 7.5% or 8%, then that will signal scope to cut rates, since it will mean that even at 7.2%, the economy is growing below potential. But if potential growth is pegged at say 7%, then the market will not expect a cut since the economy is anyways growing at potential.
Short point, the bond markets and economists await more information from the RBI and the government before they can firm up their minds on rate cut expectations.
Besides the monetary policy announcements, today’s policy made life slightly tough for banks that are dependent on too much bulk deposits. The RBI has redefined bulk deposits as those above
₹3 crore versus
₹2 crore earlier. Bulk deposits are usually cheaper for banks. Now banks will have to pay higher market rates for a slightly larger part of their deposits. But this won’t have a system-wide impact. It will squeeze margins a bit only for those banks that are too dependent on bulk deposits, a practice the RBI wants to discourage.
Finally, an excellent facility for every consumer is on the way: Until now, we could e-mandate only payments coming with regular periodicity, like say magazine subscriptions. The RBI promised that payments that are recurring but without a fixed periodicity, such as Fastag, will also be included in the e-mandate framework.
To RBI’s credit, they are getting the digital piece as right as their monetary policy.
