Rate cut hopes dashed as RBI decides to chase inflation target of 4%

• RBI makes a surprise move on incremental CRR to suck out liquidity to the tune of Rs 95,000 crore from the system as prices continue to rage.
• RBI not happy with inflation print within tolerance band, open to deploying any policy instrument to bring CPI inflation print to 4%.
• Economists unanimously rule out the possibility of a rate cut in the current calendar year. First rate cut now likely in April 2024.
  

Economists are not known to agree on anything, but after Thursday’s policy announcement by Governor Shaktikanta Das, they agree that no rate cut is likely this year. Markets can take a break and stop speculating because the war against inflation has entered a sticker phase. The Monetary Policy Committee of the Reserve Bank of India may have maintained its pause on rate action, but the rate hike cycle has not decisively ended. Revising the inflation guidance to 5.4%, RBI Governor Shaktikanta Das has made it clear that the MPC will pull every arsenal it has to bring inflation to 4%. Adding an incremental 10% CRR (cash reserve ratio) is just one of them.

From his statement it is abundantly clear that there’s no room for ambiguity. He says, “We have to stand in readiness to go beyond keeping Arjuna’s eye to deploying policy instruments, if necessary. I reiterate what I said in my June policy statement: bringing headline inflation within the tolerance band is not enough; we need to remain firmly focused on aligning inflation to the target of 4%.”

Food prices have been on the boil after CPI inflation cooled in May to 4.25% from April’s 4.7%. And the central bank has substantially increased its forecast for second quarter’s CPI inflation print to 6.7%, third quarter at 5.7% and Q4 at 5.2%. Sonal Varma of Nomura’s forecast for headline inflation to settle in the range of 5.6% for the rest of FY24. The broader belief is that while vegetable prices may cool down, prices of pulses may be stickier. Most economists are pushing back the first rate cut event to next year now.

In his statement, Das said that headline inflation projection for Q2 of 2023-24 was being revised up substantially, primarily due to the price shock from vegetables. “The frequent incidences of recurring food price shocks, however, pose a risk to anchoring of inflation expectations, which has been underway since September 2022. The role of continued and timely supply side interventions assumes criticality in limiting the severity and duration of such shocks.”

The benchmark Nifty50 index lost nearly 100 points in trade, as the market is now factoring in a prolonged pause in interest rates if not a hike. Dhiraj Relli, CEO of HDFC Securities, said that the governor has stressed on moving towards the primary target of 4% inflation. “In this backdrop, expectation of a rate cut in this calendar year seems to have faded. We expect the first rate cut perhaps in February,” he added.

The central bank is not willing to leave any door open that can lead to price instability. Despite its stance on withdrawing accommodation, systemic liquidity has been in surplus and hit a 14-month high in August. While some of this can be due to the withdrawal of currency notes in 2000 denomination, the RBI has found a way to suck out this liquidity. While the MPC has not directly hiked interest rates, the imposition of incremental CRR of 10% on NDTL (for period of May to July) would lead to a depletion of liquidity in the system by almost Rs 99,600 crore. This move will also lead to a mild hardening of short-term rates in the money markets for corporate borrowers and non-banking financial institutions.

While some economists are optimistic about the first rate cut to happen in February, with the RBI chasing a 4% CPI target, that could be more difficult. Prasenjit Basu of ICICI Securities expects policy rates to remain unchanged in calendar 2023. He expects the pause to continue through the rest of this year and the next policy move to be a rate cut in April 2024.

ALSO READ: RBI’s temp measure to absorb surplus liquidity caused by ₹2,000 note inflows