RBI Updates: RBI no longer lags behind in tackling inflation risk from geopolitical tensions

At its meeting, the MPC kept the political repo rate unchanged at 4% as expected, but what was unexpected was the decision to restore the LAF political corridor by introducing a permanent deposit facility (SDF) (not guarantee) at 3.75%. The SDF is an additional tool to absorb liquidity without any collateral.

The SDF replaced the fixed rate reverse repo (FRRR) as the floor of the LAF corridor. By introducing the SDF, the RBI restored the LAF corridor (50 bps width) with SDF at the base of 3.75% and MSF at 4.25%. While the RBI kept its monetary policy unchanged, it changed its wording to “remain accommodative while focusing on withdrawing accommodation”.

This signals that the central bank may be preparing to change its stance to neutral in upcoming policy meetings.

Clearly, priorities have shifted, with inflationary risks emanating from global factors taking center stage compared to the earlier supportive growth policy. Russia’s invasion of Ukraine fueled a rise in commodity prices around the world. Global food, commodity and metal prices have also tightened significantly.

Inflation fears have increased with the rise in oil prices, the pass-through to retail prices has begun and the secondary impact will be felt in the coming months. RBI now believes that inflation risks are no longer transitory and that the supply side shock and its input cost pressures are likely to persist even longer.

Based on these findings, RBI raised the inflation forecast from 4.5% to 5.7% for FY23, assuming a normal monsoon in 2022 and an average oil price. crude (Indian basket) of US$100 per barrel. Inflation forecasts were ahead of the consensus of economists by an increase of 50 to 80 basis points.

Food inflation is expected to come under pressure in the coming months due to high edible oil prices in international markets coupled with India’s heavy reliance on imports to meet its domestic demand. With geopolitical tensions showing no signs of letting up, the impact of rising global oil prices on the transportation sector could indirectly affect the prices of other commodities. Going forward, the pass-through of higher input prices is likely to further weigh on the broad-based nature of the inflation path.

RBI noted that the economic recovery is sound as evidenced by several high-frequency indicators – rail freight, GST collection, toll collection, electricity demand, fuel consumption and capital goods imports which showed a solid year-over-year expansion in February-March.

Business confidence is in optimistic territory and favorable to the recovery of economic activity. Investment activity could gain ground as business confidence improves, bank lending picks up, continued support from government investment spending and favorable financial conditions.

India is making steady progress on the home front, but global developments pose downside risks in terms of the fallout. Be a major oil importer; the rise in commodity prices is a negative trade shock that increases the pressure on growth. Real GDP growth for FY23 was sharply reduced from 7.8% to 7.2%, amid global shocks.

The overall liquidity of the system remains largely in excess, although it has moderated. The current average excess liquidity in the system stands at Rs 8.5 lakh crores. Access to SDF and MSF will be at the discretion of the banks, unlike repo/reverse repo, OMO and CRR which are available at the discretion of the Reserve Bank.

The introduction of the SDF at 3.75% will certainly push up overnight interest rates. The RBI is trying to flatten the yield curve by pushing short-term rates higher and would take adequate measures to ensure that yields on long-term securities remain in check.

The RBI has embarked on a path of a gradual increase in the key interest rate and a gradual withdrawal of liquidity. The days of easy money seem to be behind us, deposit and lending rates will gradually increase. Banks also benefited from a cushion on the HTM front, amid rising interest rates.

The 10-year Gsec yield crossed the 7% mark (for the first time since June 2019) and rose 15 bps to 7.06%; reaction to slightly hawkish policy, revision of GDP inflation forecasts and end of accommodative monetary policy. Although the HTM limit has been increased from 22% to 23% until March 31, 2023; bond prices took a hit as politics normalized faster than expected following the governor’s speech.

The RBI could intervene through OMO and operational twists to limit the upside to some extent. Given that the RBI has started to drain liquidity from the banking system, it is unlikely to announce direct bond purchases. A faster normalization of global politics amid persistently high inflation, high energy prices and a huge local borrowing program should keep the long-term end of the yield curve at low levels. students.

Indian bonds, if included in global bond indices in S2FY23, would provide some respite for bond market participants (although tax issues need to be addressed early to ease the process). We expect the 10-year Gsec to trade between 6.9-7.3% in S1FY23.

The announcement made it clear that RBI is no longer behind in tackling inflation risk emanating from global geopolitical tensions. He clearly paved the way for a political outcome. The focus will now be on withdrawing the accommodative policy stance while controlling inflation.

We expect the stance to shift from ‘neutral’ to ‘accommodative’ in June policy and expect a 50bp rise in the repo rate in FY23, but the timing will remain a function of developments. growth and inflation risks.

(The author is Head of Retail Research, HDFC Securities)

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