Mumbai: The Reserve Bank of India (RBI) could raise its repo rates by 40 basis points (bps) and 35 bps in the June and August reviews, while the CRR could be increased by 100 bps during the period, according to an SBI study.
CPI inflation rose to 7.79% on an annual basis in April from 6.95% in February, mainly due to food price inflation. Inflation should now remain above 7% until September. Beyond September, inflation footprints could fluctuate between 6.5% and 7%. Our inflation forecast for FY23 is 6.5%, given the possibility of a prolonged food price shock.
The Russian-Ukrainian conflict had a significant impact on the path of inflation. The latest April inflation print shows that wheat, protein products (chicken in particular), milk, lemon, cooked flour, peppers, refined oil, potato, peppers, kerosene, firewood, gold and LPG contribute substantially to overall inflation. Interestingly, the inflation of protein products like chicken, mustard oil, etc. eased in April. However, this might be an aberration, given that April was the month of Navratri and other religious festivals. This is also reflected in rising prices for milk and even fruits like mangoes.
Surprisingly, the contribution of gasoline and diesel to headline inflation has been steadily declining since October, while there is a steady increase in the weighted contribution of kerosene and firewood to headline inflation. The significant increase in the weighted contribution of kerosene perhaps reflects the impact of high fuel costs in rural areas. This does not bode well for rural demand. The weighted contribution of LPG also increased, reversing a downward trend. This can however be attributed to the commercial use of LPG.
“We now expect the RBI to raise rates at the June and August policy meeting by a cumulative 75 basis points. Beyond August, rate action could be more balanced and sensible. We expect that the terminal repo rate will be 5.15% to 5.25% by FY23. The rupiah has depreciated sharply against the dollar due to runaway inflation both in the United States and in the domestic market “Aggressive rate hikes in the US have strengthened the dollar against the basket of currencies. The dollar index rose above 104, its highest since December 2002,” says SBI Group Chief Economic Advisor Soumya Kanti Ghosh.
Based on the ASCB’s 2005 housing loan data, SBI’s internal economic research has estimated that 8.75% is the weighted average loan rate threshold for housing loans above which disbursements housing loans could decline. This is to say that RBI would not have to increase the repo rate by more than 1.25% for an additional negative contribution to come into play. With a 40 basis point hike already made in May, the repo cannot be increased by more than 80 basis points, i.e. the upper limit should be 5.25% (repo rate of 5.15% + CRR impact of 10 basis points). This would imply a full transmission of 125 basis points above and in a position to the banks current EBLR.
Meanwhile, system liquidity is still in excess mode with sustainable net liquidity at Rs 6.8 lakh crore. RBI could increase the CRR rate by another 100 basis points, after raising it by 50 basis points in the last monetary policy. This would lead to the absorption of Rs 1.74 lakh crore from the market on a sustainable basis (Rs 87,000 crore absorbed earlier).
High government borrowing has ruled out the possibility of selling OMO, so increasing the CRR appears to be the possible non-disruptive option to absorb sustainable liquidity. Also, it opens space for RBI to manage liquidity going forward through the purchase of OMO. RBI can give back to the market at least 3/4 of the Rs 2.6 lakh crore absorbed by the rise in CRR or Rs 1.95 lakh crore in some form to meet the duration offer. This would reduce market borrowing to around Rs 12.36 lakh crore for FY23 from BE of Rs 14.3 lakh crore.
Additionally, the Rupee moved north crossing the 77 mark. With the normalization of the LAF corridor, the Rupee was expected to experience some volatility. FII outflows into equities could persist as the normalization of interest rates in advanced economies will impact the growth outlook for emerging markets. The Rupee is expected to move within the Rs 75-78 range with swings on either side. The tightening of the rate outlook in the United States, leading to risk avoidance in all asset classes, saw windfalls for the dollar index whose marauding strength took it to 20-year highs, creating a free fall for many other currencies, the puzzling situation exacerbated by massive REIT outflows.
The Rupee’s fall to new lows, with volatility rising above psychological levels of 77, bodes well for a difficult situation, reflecting the turmoil in broader markets globally, and the limited choices available. the Central Bank to manage the exchange rate, even with seemingly comfortable exchange rates. foreign exchange reserve levels close to 600 billion dollars. The strategy adopted by RBI would increasingly align with NDF interventions (preferably in near months when liquidity is more important) and FX futures, with spot market intervention playing second role. It also saves reserves, with only settlement of the differential amount with counterparties on the due dates. This should restore confidence in the Central Bank’s role as a neutral, confidence-building regulator whose main task would be to reduce volatility without pushing the rupee to specific levels. We do not expect the Rupee to break through the 80 levels and instead show an appreciation bias over time.