RBI Policy Review: Not Backing Down

RBI Policy Review: Not Backing Down The RBI policy announcement today was in line with expectations with the central bank raising rate by 35bps to 6.25% and keeping the policy stance unchanged at “withdrawal of accommodation”. The policy announcement today signalled that more rate hikes are in the offing. We expect the terminal rate to be close to 6.5-6.75% in this cycle.

 More hawkish than expected: However, the policy tone was distinctly more hawkish than expected. When a central bank combines its sanguine view on growth with continued concerns on inflation – particularly the persistence in core inflation – it suggests that it is prepared to continue its fight against inflation and has the space and willingness to raise rates further. Although, in the post policy press conference, the Deputy Governor did mention that the step down in the rate hike quantum is a signal towards the fact that “50bps” rate hikes are perhaps behind us.

 Inflation battle continues: The central bank emphasized that it is not ready to let up its inflation battle and aims to bring down inflation below 6% in the near term and then closer to 4% over the medium term. The RBI projects inflation to remain above its target even in Q2 FY24 at 5.4% as per its latest forecasts.

 Wean-off the liquidity overhang: There were other signs in the governor’s statement that suggested that tightness in financial conditions could intensify going forward. While the RBI continued to re-iterate that it would continue to manage liquidity conditions through fine tuning operations, it cautioned markets to wean themselves off the surplus liquidity overhang and not take it for granted.

 Rupee defence? Today’s policy announcement does provide a soft support for the rupee ahead of the Fed meeting next week and can be viewed perhaps as an attempt by the RBI to continue aligning itself with the still hawkish G7 central banks. Furthermore, the RBI’s continued emphasis on the factors that lend support to the rupee, signals its preference for a stable rupee going forward implying intervention on both sides of the market to keep it range bound into 2023.

 Stance unchanged: The RBI justified keeping it stance unchanged at “withdrawal of accommodation” as liquidity surplus remains in surplus and the real policy rate remains negative. Despite the expectation that real positive rates are likely to move into the positive zone in the months ahead, perhaps the RBI could look at the absolute gap (aiming for it to be similar to what it was in the previous rate hike cycle) and future risks on inflation and growth before changing their stance. So, a change is stance in the February policy is still perhaps not a done deal. TREASURY RESEARCH 7 Dec 2022 econresearch@hdfcbank.com Classification – Public Classification – Public

 Macro forecasts: In terms of forecasts, GDP growth was revised down marginally by 20bps to 6.8% for FY23, although the central bank showed comfort around the current growth momentum. On inflation, the full year figure was kept unchanged at 6.7%.

 MPC voting not unanimous: The MPC decision was not unanimous with Prof Jayanth Varma dissenting on the quantum of rate hike while two members – Dr Ashima Goyal and Prof Jayanth Varma – voting against the unchanged stance decision. Market reaction: The 10-year yield rose to 7.30% (post the policy announcement) vs. yesterday’s closing level of 7.249% as the policy tone was more hawkish than expected. We expect the 10-year paper to trade closer to 7.25-7.35% in the near-term. The Fed policy meeting next week could be the next trigger for any level adjustments in the range.

On the FX front, the USD/INR was broadly flattish trading at 82.47 at the time of writing. The rupee has come under pressure this week on account of a dollar index recovery and foreign outflows. We expect the USD/INR pair to continue to trade between 82-83 levels in the near term as global risks continue to remain elevated. The Specifics: Inflation: The RBI retained its CPI inflation forecast at 6.7% for FY23 assuming average crude oil price (Indian basket) at USD 100 pbl, with risks evenly balanced.

On a quarterly basis, inflation was revised up by 20 bps for Q3 FY24 and by 10 bps for Q4 FY23. Our View: We expect CPI inflation to moderate to 6.26% in November 2022 on account of a sequential moderation in food prices and base effect. We expect inflation to remain above the RBI’s upper band of 6% until Jan 2023. For the full year, we expect CPI Inflation to average 6.7% in FY23. Inflation Projections %YoY Q3 FY23 Q4 FY23 FY23 Q1 FY24 Q2 FY 24 RBI (September forecast) 6.4 5.8 6.7 5.0 – RBI (December forecast) 6.6 5.9 6.7 5.0 5.4 HDFC Bank (Forecast) 6.4 5.9 6.7 4.8 5.1 Source: RBI and HDFC Bank Growth Outlook: The RBI lowered its growth forecast by 20 bps to 6.8% for FY23 (from 7.0% earlier).

The RBI expects investment to pick up with support from government capex and strengthening bank credit. On the consumption side, rebound in the contact intensive sector and improvement in business & consumer sentiment is likely to support urban consumption. That said, the RBI continues to see spill econresearch@hdfcbank.com Classification – Public Classification – Public overs from prolonged geo-political tension, tightening global financial conditions and slowing external demand as key risks to the growth.

Our view: We expect GDP growth of 6.8% in FY23 and expect growth in Q3 & Q4 to be between 4-4.5%. For FY24, we expect GDP growth of 6%, with downside risks to our forecasts. There are risks stemming from the slowdown in global growth and impact of inflation and tighter financial conditions on the consumption recovery. Growth forecast Source: RBI and HDFC Bank Additional Measures: SLR Holdings in Held to Maturity (HTM) category: The RBI has extended the dispensation of enhanced HTM limit of 23% up to March 31, 2024, to provide flexibility to banks in managing their investment portfolios.

Extension of Bank’s HTM limits will be restored to 19.5% from 23% in a phased manner starting from the quarter ending June 30, 2024. Hedging of Gold in the International Financial Services Centre (IFSC): Resident entities will now be permitted to hedge their gold price risk on recognized exchanges in the IFSC. The RBI raised the policy rate by 35 bps to 6.25% System liquidity surplus rose from November lows. As of 6th December, system liquidity surplus stood at INR 1.72 lakh Cr Source: RBI, CEIC, HDFC Bank. Note: Latest WACR data as of 6th December. Source: RBI, CEIC, HDFC Bank. %YoY Q3 FY23 Q4 FY23 FY23 Q1 FY24 Q2 FY24 RBI (September forecast) 4.6 4.6 7.0 7.2 – RBI (December Forecast) 4.4 4.2 6.8 7.1 5.9 HDFC Bank (forecast) 4.3 4.4 6.8 7.0 – econresearch@hdfcbank.com Classification – Public Classification – Public Bond Yields: Long end yields moved up as the RBI was more hawkish than expected Source: Reuters, HDFC Bank.

Pre RBI Post RBI Cumulative Change (in bps) G-Secs 3M 6.36 6.39▲ 3 6M 6.70 6.74▲ 4 1Y 6.76 6.87▲ 11 5Y 7.10 7.16▲ 5 10Y 7.25 7.28▲ 3 30Y 7.35 7.39▲ 4 Corporate bonds 3M-CP 6.85 6.87▲ 2 6M-CP 7.36 7.38▲ 2 10Y-AAA 7.93 8.39▲ 47 10Y-AA 8.07 8.18▲ 12 OIS 1M 6.29 6.26▼ -3 3M 6.35 6.39▲ 4 6M 6.54 6.58▲ 4 1Y 6.61 6.68▲ 7 econresearch@hdfcbank.com Classification – Public Classification – Public Treasury Economics Research Team Disclaimer: This document has been prepared for your information only and does not constitute any offer/commitment to transact. Such an offer would be subject to contractual confirmations, satisfactory documentation and prevailing market conditions. Reasonable care has been taken to prepare this document. HDFC