By Madhavi Arora
- The policy pivot by the RBI reflects their discomfort with inflation amid changing macro realities, as it again takes precedence over growth in their reaction function. The move towards being less accommodative is accompanied by hike in effective floor rate by 40bps with addition of uncollaterised SDF as new liquidity tool at 3.75%, while fixed reverse repo rate becomes mostly redundant. The move will ensure call rate would eventually edge towards the new effective corridor of 25bps -/+ Repo rate.
- With inflation forecast upped by 120bps, the RBI no longer think the output sacrifice required to tame supply-driven inflation can be as high. The change in stance could formally materialise in the next policy, with the rate hike cycle commencing in August, while not fully precluding the case for a June hike itself along with a stance change if inflation realities worsen. FY23 could thus see rates going up by 75-100bps, and the terminal rate may be a tad higher than 5% with RBI now showing intent to keep real rates neutral.
- Various global and domestic push-and-pull factors will challenge the gradualist approach toward liquidity normalization. Nonetheless, a huge bond supply in FY23 will require the RBI’s invisible hand, (f tactical OMOs), which the RBI may neutralize partly with CRR hikes later if it intends to bluntly reduce banking liquidity. Operation Twist, while an attractive option to ease term premia, may be constrained due to thin Gsec residual maturity profile in the RBI’s book. We maintain that a mild bear-flattening bias in the Gsec curve may prevail.
RBI pivots: Prepping for a formal stance change
The RBI has finally crawled towards change in policy stance by being “less accommodative while focusing on withdrawal of accommodation” even as it kept the policy repo rate unchanged unanimously. The move towards the stance adjustment is not a big surprise as the RBI has send clear message last policy that any stance change will be pre-telegraphed. This stout signaling prepares the markets for eventual pivot ahead. The move is also accompanied by addition of overnight SDF as a new instrument to the liquidity management framework, placed at (-)25bps of repo rate and (+)40 bps above the current fixed reverse repo rate (FRRR) to absorb surplus liquidity. This will effectively now serve as the new floor of the policy corridor, symmetric with MSF rate which is 25bps higher than repo rate. However, RBI also maintained that they will continue to adopt nuanced and nimble approach to liquidity management even as they more towards normalisation going ahead in a multi-year cycle.
SDF adds to policy flexibility but leads to effective hike in floor rates by 40 bps
We had argued in our thought piece a quarter ago that the time is ripe for SDF introduction; which would not only alleviate the collateral constraint but if effectively used, could have multiple benefits in policy flexibility on financial stability and for banking sector as well. The journey from current ~Rs8tn+ system liquidity to a pre-Covid Rs2tn+ will be a long-drawn one and new tools like SDF will be needed to manage durable liquidity/any idiosyncrasies amid any collateral constraints under VRRRs. That said, the FRRR at 3.35 , even though keeps a lower overnight bias to policy corridor, now becomes largely redundant as now it is going to be used at the discretion of the RBI. In nutshell, the move would ensure the call money rate would eventually edge towards the new effective corridor of 25bps -/+ Repo rate.
Inflation, my old foe, here we meet again
Amid new macro realities, the inflation forecast has been made more realistic at 5.7% from 4.5% earlier (Emkay: 5.8%+) with Brent at $100/bbl and higher commodity complex in general, which again adds bias to their move towards policy rationalisation. The growth looks to be printing the lows of 7.2%, with further persistent slack;The RBI reckoned that inflation has taken precedence over growth in their reaction function.
Doves are bidding goodbye: June is a live policy
Overall, the policy calibration is well appreciated– crawling towards withdrawal of “ultra-accommodation”, with policymakers making the liquidity normalisation long drawn multi-year process. However, with reaction function pivoting back towards inflation over growth as policy priority, the bias is clear. This also implies that the policymakers no longer think the output sacrifice required to tame supply-driven inflation can be as high. Thus, to that extent RBI no longer a stout dove and the reaction function is now evolving with fluid macro realities. The change in stance could formally materialize in the next policy, even as the RBI crawl towards liquidity normalization. This also raises the probability of rate hike cycle commencing in August, while not fully precluding the case for a June hike itself along with a stance change if inflation realities worsen. FY23 could thus see rates going up by 75-100bps, and the terminal rate may be a tad higher than 5% with RBI now showing intent to keep real rates neutral.
…but the journey of liquidity transition will still be edgy
The gradualist approach toward liquidity and rate normalization may be challenged by various global and domestic push-and-pull factors. Nonetheless, a huge bond supply in FY23 will require the RBI’s invisible hand, implying the return of tactical OMOs, especially as the BoP deficit could soar to USD50bn in FY23. The RBI may neutralize this partly with CRR hikes later if it intends to bluntly reduce banking liquidity, albeit will face communication challenges. Operation Twist, while an attractive option to ease term premia, may be constrained as the residual maturity profile of Gsec in the RBI’s book (12-15 months) could be thin. We maintain that a mild bear-flattening bias in Gsec curve. may prevail.
(Madhavi Arora is Lead Economist at Emkay Global Institutional Equities desk. The views expressed are author’s own.)
