RBI Policy: RBI Turns To Tighter Policy; expect bond yields to continue to harden this year
The MPC, while reiterating its dovish stance, also rephrased emphasizing the withdrawal of accommodation as it ensures inflation remains within target with continued support for growth. Amid concerns over geopolitical conflicts and soaring global commodity prices; inflation forecasts have been revised upwards and growth projections are revised downwards for all quarters of FY23.
Domestically, the MPC noted that the economy was showing signs of recovery, as evidenced by high-frequency indicators as well as buoyant merchandise exports. Expectations of higher Rabi production bode well for rural demand as well as food prices. Private investment activity will be further stimulated by government programs such as the PLI. However, there have been significant changes in the macroeconomic environment since the last meeting (February 22). This is due to the uncertainty of the current geopolitical framework, as well as tighter global financial conditions and soaring global crude and commodity prices which may harm growth prospects. As a result, RBI lowered its growth forecast to 7.2% for FY23 (7.8% in Feb 22), Q1FY23 to 16.2% (from 17.2%), Q2FY23 to 6.2 %, T3 and T4FY23 at 4.1% and 4%, respectively.
On the inflation front, the RBI governor said he had revised inflation projections upwards due to evolving geopolitical tensions and its impact on global commodity prices. The Committee noted that it remains vigilant as it continues to monitor elevated global pressure on food prices, including edible oils. These disruptions will also add pressure on input costs. In the above context as well as the assumption of a normal monsoon and crude oil at 100 USD/bbl, the MPC has revised its forecast to 5.7% for FY23 (4.5% previously) , for T1FY23 at 6.3% (4.9% earlier), Q2FY23 at 5.8%, Q3FY23 and Q4FY23 at 5.4% and 5.1%, respectively.
The RBI said that liquidity in the system continues to remain in large excess with an average absorption below the LAF window of Rs 7.5 lakh crore in March 2022. The central bank RBI indicated that given the current macroeconomic conditions and the tightening by other major global central banks, RBI’s response will also be “pre-emptive and dynamically recalibrated to the changing outlook”. Currently, RBI manages liquidity in the system through Variable Repo Rate (VRRR) auctions and overnight reverse repo transactions.
These tools will continue to be used. The policy also confirmed that in order to avoid market shocks, the RBI had absorbed around 80% of liquidity at rates close to the repo rate (4%) via VRRR. Thus, the normalization of the LAF corridor at 3.75-4.25% (50 basis points; at pre-Covid-19 levels) was in line with expectations.
To better manage liquidity, RBI has introduced a new tool, SDF (Standing Deposit Facility) or permanent absorption facility. This will act as the floor of the LAF corridor and will be set at 25 basis points below the repo rate (currently 3.75%). The main difference between the Reverse Repo facility and the SDF is that in the case of the SDF, RBI has no binding collateral constraints. The upper end of the LAF corridor will be the Marginal Standing Facility (MSF), which will be 25 basis points above the repo rate (currently 4.25%). With the introduction of the SDF, the usability of the Fixed Rate Reverse Repo (FRRR) will decrease as the rate remains unchanged at 3.35%.
In addition, RBI has also announced that there will be a “calibrated withdrawal” of the current surplus of excess liquidity of Rs 8.5 lakh crore in the system. This will be done in a multi-year framework, with a withdrawal from the current fiscal year FY23.
Some other key additional measures announced by the RBI were as follows:
In October 2020, RBI had increased the Held-to-Maturity (HTM) category limits from 19.5% to 22% NDTL with respect to securities eligible for the Statutory Liquidity Ratio (SLR) acquired from from September 1, 2020. This limit has been increased to 23% until March 31, 2023. From the first quarter of FY24, the limit will begin to be reduced from 23% to 19.5% on a gradual basis.
In October 2020, RBI had streamlined the risk weights for individual home loans by linking them only to loan-to-value (LTV) ratios for all new sanctioned home loans until March 31, 2022. This facility has been extended to all sanctioned home loans. until March 31, 2023.
A discussion paper on climate risk and sustainable finance will be placed by the RBI. This is due to the need for Regulators (REs) to develop and implement a robust process to understand and assess the potential impact of climate-related financial risks in their business strategy and operations. This would require an appropriate governance structure and policy framework to effectively manage and address these risks.
RBI has proposed to set up a committee to review and review the state of customer service in Regulatory Entities (REs) and the adequacy of customer service regulation and suggest measures to improve it .
RBI proposed that all banks and ATMs support the cardless withdrawal feature. To encourage ease of cardless cash withdrawals at all banks and ATM networks/operators, it is proposed to enable customer authorization through the use of the Unified Payment Interface (UPI) , while the settlement of these transactions would take place through the ATM networks.
Bharat Bill Payment System (BBPS) – RBI has proposed the streamlining of Net Worth Requirement for Business Units (BBPOU). The current net worth requirement for a non-bank BBPOU to obtain a license is Rs 100 crore and is seen as a constraint for greater participation. Therefore, RBI has reduced the net worth requirement for non-bank BBPOUs to Rs 25 crore.
Payment System Operator (PSO) Cyber Resilience and Payment Security Controls – With greater adoption of digital payment methods, RBI had prescribed the necessary security controls for digital payment products and services offered by PSOs. banks and NBFCs issuing credit cards. Now, similar instructions have been issued for operators of payment systems (PSOs).
The RBI policy is no longer dovish, which led to bond yields tightening after the policy was announced. RBI’s concern over inflation has increased significantly, especially with the average inflation estimate for FY2023 revised up by 120 basis points. The RBI in this policy has shifted its focus towards inflation rather than growth.
Although there is no mention of Operation Twist or Open Market Operations in the RBI policy, we expect the RBI to use these tools from time to time to manage the yield curve effectively in order to help carry out the big borrowing program in the market smoothly. way.
However, we expect bond yields to continue to tighten over the course of the year, due to further rate hikes expected later in the year in India, monetary policy normalization by major banks power plants, high crude oil prices and supply side pressures from heavy market borrowing in FY23. From a debt markets perspective, we currently favor the medium term of the yield curve.
Stock markets also applauded the hawkish monetary policy today. The recovery in corporate earnings in India will help markets feel the return to normalcy of the domestic economy. We believe the economic recovery will continue as the pandemic effect slows down in the economy. However, ongoing geopolitical tensions, high stock market valuations, rising commodity prices and upcoming quarterly results may cause some volatility in the market in the near term and lead to subdued equity market returns over the coming months. coming year (compared to the previous year).
(The opinions expressed by the author in this article/note should not be construed as investment advice and readers are urged to seek independent financial advice before making investment decisions)