The Reserve Bank of India is likely to deploy non-interest rate measures to ensure that its action of raising borrowing costs by 250 basis points since May 2022 is fully passed on to borrowers to combat rising inflation. A big chunk of the increase is yet to be passed on.
The transmission of policy rates by commercial banks has trailed the pace of rate hardening by the RBI, which cumulatively raised the repurchase rate since the summer of 2022. The transmission ranged between 107 bps and 228 bps over this period, although the central bank halted the rate increases early 2023.
The weighted average lending rate (WALR) on fresh rupee loans rose 146 bps in the current rate hike cycle. The WALR on outstanding rupee loans rose 107 bps. The weighted average domestic term deposit rate (WADTDR) on fresh rupee term deposits increased 228 bps in the current cycle, while the weighted average domestic term deposit rate (WADTDR) on outstanding rupee term deposits rose 184 bps. “With banks raising both deposit and lending rates, the pace of monetary transmission is picking up again,” said Rahul Bajoria, head of EM Asia (ex-China) economics, Barclays. “Hence, the RBI may see little need to tighten liquidity incrementally either through signalling or outright actions.”
The central bank is likely to focus on non-rate measures for the sixth time when the Monetary Policy Committee (MPC) meets this week. By announcing a lower-than-expected government borrowing programme, the government has done its bit by helping push down yields.
With a lower-than-expected fiscal deficit, the government’s gross borrowing is expected to fall by 8.4% in FY25.
“This provides support to long-end bond yields, especially in the context of India’s impending bond index inclusion by June 24. As such, a decrease in government borrowing will improve the liquidity situation,” wrote Morgan Stanley in a note
In terms of the impact on rates, yields on ten-year government bonds fell by at least 10 bps (one basis point is 0.01%) in the two days since the interim budget announcement on February 1.
RBI is expected to keep the policy repo rate unchanged at 6.50% at the February 8 policy meeting, continue with its hawkish guidance, and reiterate the 4% inflation target, according to Goldman Sachs. “We further expect the RBI to retain its tight liquidity stance (as signalled by the comment that they will “remain focused on withdrawal of accommodation to ensure that inflation remains within the target going forward, while supporting growth,” said Santanu Sengupta, chief India economist at Goldman Sachs.
As for inflation, food inflation could be sticky nearing 7%, though core inflation is well within the RBI target of 4%. The central bank’s attempt to manage inflation expectations could be through liquidity measures.
“While the RBI’s MPC is likely to keep the repo rate unchanged on February 8, we expect the first steps to address tight frictional liquidity and a more active discussion on removing the tightening bias from the guidance,” said Sonal Varma and Aurodeep Nandi of Nomura’s Asia Economics team. “In our base case, we expect 100 bps of rate cuts, starting from August, with risks skewed towards earlier easing in June”.