The Reserve Bank of India has increased the repo rate by 25 basis points in its Monetary Policy, February, 2023. As the repo rate has increased from erstwhile 6.25 per cent to 6.50 per cent, the standing deposit facility (SDF) rate has correspondingly been adjusted to 6.25 per cent and the marginal standing facility (MSF) rate and the Bank Rate to 6.75 per cent. At this level, the repo rate is at its four-year record level. It is the sixth consequent increase in it but at the lowest pace amongst them all. This is depicted in the Chart 1 below:
The slow-down in the pace of interest rate hike was made possible due to inflation coming back within the upper target range of 4-6 per cent. Also, it is projected to remain around 5.3 per cent in the financial year 2023-24. However, the monetary policy committee has continued with its hawkish instance towards ‘withdrawal of accommodation’ to ensure that inflation remains within the target while going forward. Also, it has not given any specific indication about any pause or continuation either of the interest rate hike.
According to the RBI, the calibrated monetary policy is required ‘to keep the inflation expectations anchored, break persistence of core inflation and thereby strengthen the medium-term growth prospect.’ It is further observed that the inflation adjusted real inflation rates have continued to remain below the pandemic levels. Besides, the liquidity in the banking system remains in surplus despite pandemic related massive measures taken up by the RBI and the government.
Global economy seems to be improving yet it remains challenging
Many central banks around the world have signaled pause in their respective tightening measures as consumer inflation is getting subdued and growth rates are improving in their economies in the recent months. Yet the focus remains on their commitment towards bringing down inflation close to their targets. Besides there is volatility about bond yields. Even as the US dollar has peaked out, and equity markets have moved higher since the last MPC meeting, the emerging economies are still facing the brunt of weak external demand in major advanced economies (AEs), the rising incidence of protectionist policies, volatile capital flows and debt distress.
Domestic economy shows resilience
The domestic economy seems to be quite resilient. According to the first advance estimates (FAE) released by the National Statistical Office (NSO) on January 6, 2023, India’s real gross domestic product (GDP) growth is estimated to be 7.0 per cent year-on-year (y-o-y) for 2022-23 largely driven by private consumption and investment. Further, on the supply side, gross value added (GVA) was estimated at 6.7 per cent.
High frequency indicators suggest that economic activity has remained strong in second half of the current financial year across all sectors. Talking about the farm sector, the area under Rabi crop has exceeded last year’s area by 3.3 per cent as on February 3, 2023. There is growth reported in the industrial production by 7.1 per cent in November, after a contraction by 4.2 per cent in the month of October. Even the capacity utilization in manufacturing has now exceeded its long period average. Besides, port freight traffic, e-way bills and toll collections were all reported to be showing improvement in December. Also, the Purchasing managers’ indices (PMIs) for manufacturing as well as services remained in expansion mode in January, even as they moderated a bit compared to the previous month.
On the consumption front, the domestic demand has been supported by discretionary spending. It is well reflected by improved passenger vehicle sales and domestic air passenger traffic. Investment activity too seems to be improving as there was an increase in the Non-oil non-gold imports in December even as the merchandise exports declined due to weak global demand.
The CPI headline inflation has moderated to 5.7 per cent year on year basis in December 2022 even as it already had eased out to 5.9 per cent in November. The Core CPI (i.e., CPI excluding food and fuel) inflation , however, rose to 6.1 per cent in December due to persistence of price pressures in health, education and personal care and effects.
Further, the overall liquidity in the banking system continued to remain in surplus and the average daily absorption under the Liquidity Adjustment Facility (LAF) increased to ₹1.6 lakh crore during December-January from an average of ₹1.4 lakh crore in October-November. On a y-o-y basis, money supply (M3) increased by 9.8 per cent as on January 27, 2023, while non-food bank credit rose by 16.7 per cent. Besides, India’s foreign exchange reserves were reported to be at US$ 576.8 billion as on January 27, 2023 which also may be considered as a positive sign for the Indian economy.
Outlook for the current financial year remains mixed:
The RBI considers the outlook for inflation as mixed. While the prospects for the rabi crop have improved, the risks from adverse weather events may affect the yield from crops. Also, in the global economy, the uncertainty about the future movement of global commodity prices on account of demand pressures resulting out of easing out of the covid restrictions and disruptions through continuing geo political tensions still persist. Higher commodity prices may push up the input costs which may pressures on core inflation.
However, the Reserve Bank’s enterprise surveys, for now, have given indication of some softening of input cost and output price pressures in manufacturing. Considering these factors and assuming that the average crude oil price may be around US$ 95 per barrel, inflation is projected at 6.5 per cent in 2022-23 and the current financial year at 5.3 per cent for 2023-24 (Refer Chart below)
Source: RBI Monetary Policy Statement, 2022-23 Resolution of the Monetary Policy Committee February 6-8, 2023
Further the RBI observes that while the stronger prospects for agricultural and allied activities are likely to boost rural demand, the rebound in contact-intensive sectors and discretionary spending is likely to boost urban consumption. Businesses and consumers surveyed by the Reserve Bank have indicated optimistic outlook. Further, strong credit growth, resilient financial markets, and the government’s continued thrust on capital spending and infrastructure are all going to create a congenial environment for investment. However, the external demand may be adversely affected by a slowdown in global activity, and may hurt our exports. Taking all these factors into consideration, real GDP growth for 2023-24 is projected at 6.4 per cent. (Refer Chart above)
Reference: This article is published by the Author in the Newsletter “KnowFunda Digest” (8th Edition) on LinkedIn on February 15, 2023.