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Pragmatic policy; expect rates to increase by another 25-50bps in FY23

* The monetary policy committee (MPC) unanimously voted for a 50bps hike in the repo rate. This was marginally higher than our expectation of a 35bps hike. The repo rate now stands at 4.90%, the standing deposit facility (SDF) rate at 4.65% and the marginal standing facility (MSF) rate at 5.15%. We expect additional rate hikes of 25-50bps in FY23.

* The MPC also unanimously voted to focus on withdrawal of accommodation. The RBI will move towards normal monetary policy in a calibrated manner. The Governor clarified in the press conference that normal monetary policy meant that the call rates should be close to the repo rate rather than the SDF rate.

* RBI noted that upside risks to inflation have manifested earlier than expected. Consequently, Inflation is expected to be above 6% for the first three quarters of FY23. RBI has revised up its inflation projection for FY23 to 6.7% from 5.7% earlier with 1Q at 7.5%, 2Q at 7.4%, 3Q at 6.2% and 4Q at 5.8%. This assumes crude at US$105/bbl. This is closer to the upper bound of our inflation forecast while our base case is at 6.2% (assuming cooling off in commodity prices in 2HFY23 on global policy tightening and consequent slowdown).

* The Governor pointed out that 75% of the increase in the inflation projection is attributed to food articles. At the same time, he also noted that fuel tax cuts have reduced the three month ahead inflation expectations of urban households by 190bp and 1 year ahead inflation expectations by 90bp.

* RBI retained its GDP forecast for FY23 at 7.2% with 1Q at 16.2%, 2Q at 6.2%; 3Q at 4.1% and 4Q at 4%. Notably, capacity utilisation has improved to 74.5% in 4QFY22 from 72.4% in 3QFY22.

* The Governor reiterated his commitment to orderly completion of the government borrowing programme. We expect the 10 - year to trade ~7.5% levels. Any significant spike may be met with intervention from RBI.

Outlook for policy –calibrated move towards normal monetary policy; expect 25-50bps of rate hikes:

The protracted war in Europe and the accompanying sanctions have kept global commodity prices elevated across the board. This is exerting sustained upward pressure on consumer price inflation, well beyond the targets in many economies. Globally, stagflation concerns are growing and are amplifying the volatility in global financial markets. This is feeding back into the real economy and further clouding the outlook. The MPC noted that, in such a challenging global environment, domestic economic activity is gaining traction, while inflation pressures have intensified further. The upside risks to inflation as highlighted in the April and May 2022 policies have materialised earlier than anticipated – both in terms of timing and magnitude. Inflationary pressures have become broad-based and remain largely driven by adverse supply shocks. There are growing signs of a higher pass-through of input costs to selling prices. The MPC noted that inflation is likely to remain above the upper tolerance band of 6% through the first three quarters of FY23. In this context, supply side measures taken by the government in reducing excise duties on petrol and diesel, along with the other measures would help in mitigating the inflationary pressures to some extent. The MPC also recognised that sustained high inflation could unhinge inflation expectations and trigger second round effects. It, therefore, judged that further monetary policy measures are necessary to anchor the inflation expectations. Accordingly, the MPC decided to increase the policy repo rate by 50 basis points to 4.90%. The MPC also decided to remain focused on withdrawal of accommodation to ensure that inflation remains within the target going forward, while supporting growth. The Governor noted that the repo rate still remains below its pre-pandemic level. Consequently, We expect additional repo rate hikes of 25-50bps over the next two policy meetings.

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