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Unmesh Kulkarni – Managing Director and Senior Advisor at Julius Baer India

The monetary policy was on expected lines, and the fixed income markets were pretty much anticipating the 50 basis point hike in policy rates, especially after the 75 bp hike by the US Fed along with their hawkish messaging.

Overall, the Monetary Policy Committee (MPC) is concerned about the emerging shocks on the global front – Covid shocks followed by Ukraine shocks and, now, the rate hike aggression shocks by global central banks – as these shocks tend to have spillover effect on other economies.

On the other hand, the RBI Governor exuded a lot of confidence around the state of the Indian economy – resilience of domestic demand, encouraging signs around credit growth, capacity utilisation, the government's thrust on capital expenditure, and the strength of our forex reserves along with better performance of rupee vis-à-vis other currencies.

On the liquidity front, given the advanced stage of tightening that we are already in, one would have expected an official change in the policy stance to include the word “tightening”; however, the MPC has chosen to stay with the stance “withdrawal of accommodation”. RBI has been successful in bringing down the excess system liquidity through its VRRR (variable rate reverse repo) auctions. The money markets have reacted sharply to the tightening liquidity, with the call rates hovering around 5.75 percent – 5.85 percent in the past one week, and closer to the enhanced repo rate of 5.90 percent.

Also read - As RBI raises repo rate, here are 10 rate-sensitive stocks to bet on

Inflation remains on the higher side and above the RBI’s comfort zone. The RBI has retained its overall projections for inflation (as per the previous policy) and expects CPI to moderate sequentially over the next few quarters, from the current expected 7.1 percent in the second quarter to five percent in FY24. Despite easing of crude oil prices and food inflation, RBI perceives uncertainty on the overall inflation trajectory on supply concerns as well as the strength of the US dollar (leading to imported inflation).

Given the lower-than-expected GDP growth in the first quarter (13.5 percent versus projected 16.2 percent), the MPC has lowered its growth outlook for FY23 from 7.2 percent to seven percent, but raised the growth outlook for the coming quarters, as well as for the first quarter of FY24 (7.2 percent versus earlier projection of 6.7 percent). This projection seems optimistic and will likely be tested over time, as the world is staring at a recession, and not a phase of accelerated growth, as a fallout of the continuous and massive rate hikes by global central banks.

Also read - RBI Monetary Policy Live Updates: MPC to discuss RBI's reply to government on failing to meet inflation target

Overall, the policy managed to perform a balancing act, between inflation and global concerns on the one hand, and providing optimism around the domestic growth/demand situation on the other. We do expect the RBI to continue on the path of rate hikes for some more time (December and February policies).

Although the Governor mentioned that the MPC would avoid providing guidance around a terminal policy rate, it would be reasonable to assume a repo rate of 6.5 percent at the end of FY23, especially against the backdrop of an aggressive Fed, dollar strengthening and rising global bond yields.

In the near term, as fixed income markets had already priced in this 50 bp rate hike, there is a possibility of some pullback in yields; however, the yield curve will continue to be under upward pressure until the markets start sensing that we are close to the end of the tightening.

The Reserve Bank of India is expected to increase its policy rate by half a point for the third time in a row as the currency’s plunge to a record low this month complicates the battle against inflation.

The Reserve Bank of India’s six-member monetary policy committee will raise its repurchase rate by 50 basis points to 5.9%, according to 34 of 46 economists surveyed by Bloomberg as of Thursday. Eleven forecast the rate will rise by 35 basis points to 5.75%, while one sees a quarter-point increase.

Governor Shaktikanta Das may opt to dial up his hawkish rhetoric from his tone at the August meeting when he pledged to do “whatever it takes” to cool inflation that has stayed above 6% this year. Since then, India’s price gains quickened anew and the currency slump deepened as the Fed raised rates by 75 basis points for a third consecutive time and amplified a hawkish signal while warning of a painful slowdown needed to curb US inflation.

“The biggest point of worry currently is the significant depreciation in the currency,” said Upasna Bhardwaj, chief economist of Kotak Mahindra Bank Ltd. Deteriorating reserves curtail RBI’s ability to intervene so “higher interest rates will have to be maintained with hawkish tone in the policy to support the rupee.”

Here’s what to watch out for when Das addresses media:

Oil, Food Prices

With oil prices falling below $80 a barrel from more than $120 in June, the RBI will probably revise its oil price assumption on Friday from the $105 level it factored in previously. It’s unlikely to make any significant changes to this year’s 7.2% economic growth forecast, or 6.7% inflation outlook, given pressures from food grain prices.

“The inflation-growth mix is likely to remain tricky,” HSBC Holdings Plc economists led by Pranjul Bhandari wrote in a note this week. They expect the RBI to hike by 50 basis points each at the September and December meetings and see average inflation staying above the 4% mid-point of the RBI’s target range in the current and next fiscal years as economic growth slows.

In a separate survey by Bloomberg on India’s economy, retail inflation is seen to average at 5.1% next fiscal year from a 6.6% estimate in the year ending March while the latest projections on economic growth moderated to 7% and to 6.1% for fiscal years 2023 and 2024. Economists polled on the policy path expect the key rate to rise by another 25 basis points by March 2023 after a half-point hike on Friday.

FX Reserves

The rupee is down about 10% this year and trading near a record low even after the RBI mounted a staunch currency defense in the past year -- evident from an almost $100 billion drop in its foreign-currency reserves, with some of the decline attributed to revaluation. Das had said the reserves “provide a cushion against external shocks.”

A broad consensus among market participants was that anything lower than a 50 basis-point hike, or the governor sounding less hawkish may push the currency even lower.

“Rupee readjustment is catching up faster than peers, as it was held artificially stronger in past adjustments by policy intervention,” Madhavi Arora, lead economist at Emkay Global Financial Services wrote in a note, “The FX war chest has already dipped an estimated more than $100 billion, while the war is still pretty much on.”

Bonds, Liquidity

Bond traders are watching for signs from the central bank on how it plans to manage liquidity in the financial system that’s been tightening.

While the RBI’s intervention in the foreign-currency market is reducing the supply of rupees, increased domestic activity after a broad reopening from virus restrictions has contributed to the strain.

The liquidity crunch along with RBI’s rate hikes are reflected in rising shorter-term borrowing costs. Five-year yields are edging higher than benchmark 10-year notes, and a flattening yield curve is delivering the narrowest spread between 10- and 2-year yields since 2020.

The bond market is also awaiting the results of index reviews by FTSE Russell and JPMorgan Chase & Co. and whether or not India will be included.