The Monetary Policy Committee of the Reserve Bank of India, as widely expected, continued to stand pat on the policy repo rate and the stance, but Governor Shaktikanta Das offered enough caution that rate hikes are not off the table. This is despite the markets seemingly positioned for a prolonged pause in rate actions.

The markets, the bonds one in particular, were relieved initially that there were no surprises in the form of rate hikes or widening of the LAF corridor through an increase in the MSF rate, but they fretted later when Das said the central bank would resort to bond sales to keep liquidity tight for controlling inflation. The 10-year yield jumped 10 basis points.

Government and corporate bond yields are expected to inch up in the coming days a key takeaway from Das was that the central bank will not consider rate cuts until inflation is at 4⁒ on a durable basis.

Many economists will now be forced to revisit their expectations of a rate cut in April or July. In fact, some may see room for a rate hike in December if the US Federal Reserve hikes again in November and the high food inflation holds.

ACTION REPLAY

The RBI's MPC left the policy repo rate unchanged with a 6-0 vote. It retained the stance of withdrawal of accommodation with a 5:1 vote. As has been the case recently, external member Jayant Verma did not support the wording of the stance.

The GDP forecast for FY24 was retained at 6.5⁒, with risks evenly balanced. The projection for GDP growth in the first quarter of FY25 was also kept at 6.6⁒.

The forecast for FY24 inflation was retained at 5.4⁒ despite the spurt in CPI in July and August. The forecast for the first quarter of the next financial year was also maintained at 5.2⁒.

In a separate document accompanying the MPC resolution, the RBI, in its Monetary Policy Report, said inflation for the last quarter of the next financial year, 2024-25, could be 4.3⁒. GDP growth for FY25 is expected at 6.5⁒, the same as the FY24 projection.

In that sense, the RBI's econometric models are showing inflation closer to its target of 4⁒ only late next financial year.

The RBI has held the repo rate at 6.50⁒ for eight straight months. It has been on a hawkish pause since April. And at each round of the MPC meetings, the hawkishness has only increased.

The RBI has said it is still waiting for the cumulative effect of the hikes in the repo rate in 2022-23, by 250 basis points, to play out for holding the policy rate again this time around.

In recent policies the RBI has been mainly operating on the liquidity channel to keep the monetary policy tight and the stance hawkish, implying it stands ready to hike the repo rate quickly if needed.

FLOAT LIKE A HAWK, STING…

The hawkish quotient in the RBI's statements has risen steadily.

Das said the RBI has identified high inflation as a significant risk to macroeconomic stability and sustainable growth and is firmly focused on aligning inflation to the 4⁒ target on a durable basis.

The RBI may not change its stance if the alignment of inflation to the 4⁒ target is not durable, Das warned in his media interaction.

The RBI worries that the overall inflation outlook is clouded by uncertainties from the fall in kharif sowing for crucial crops such as pulses and oilseeds, low reservoir levels, and volatile global food and energy prices.

It is concerned that the recurring incidence of large and overlapping food price shocks could make inflation generalised.

"The MPC remains highly alert and prepared to undertake timely policy measures, as may be necessary, in order to align inflation to the target and anchor inflation expectations", Das said in his address.

The RBI acknowledged that food inflation pressures may not see a sustained easing in the next three months. External factors like energy prices and financial market conditions could continue to be volatile and test the central bank.

"Monetary policy has to be in absolute readiness to take appropriate and timely action to prevent any spillovers from food and fuel price shocks to underlying inflation," Das said.

"These are non-negotiable necessities".

LIQUIDITY CHANNEL

The RBI had imposed an incremental cash reserve ratio of 10⁒ in its August policy to drain around 1 trillion rupees, which would unwind fully this week.

According to Das, the RBI will now switch to open market operations by selling government bonds to tighten liquidity.

The RBI has yet to spell out the quantum of bonds it intends to sell, but the message is quite clear: the RBI will tighten liquidity to keep inflation and inflationary expectations in check.

"Excessive liquidity can pose risks to both price and financial stability", Das said.

The RBI relied excessively on moral suasion this time to impress upon banks to manage their surpluses better and to watch who they were lending to.

Das noted that big banks preferred to park their surpluses in Standing Deposit Facility, which pays only 6.25⁒, instead of lending to other banks,

Lending in call money could get them 6.50-6.75⁒.

Governor Das asked banks to strengthen their internal surveillance mechanisms and address the build-up of risks, noting that personal loans are recording very high growth.

"The need of the hour is robust risk management and stronger underwriting standards," Das said.

The RBI will likely announce some macroprudential measures if the growth in retail loans, particularly unsecured ones, does not taper off.

It was mainly an action replay from the RBI. A hawkish pause was expected, and the same was delivered.

Bond yields rose as open market operations, although expected in the context of India's inclusion in the bond indices, were not expected to become an essential cog in the RBI's liquidity management procedures.

The trading range for the 10-year government bond will likely shift from 7.15-7.25⁒ to 7.30-7.35⁒ in the coming days, especially if the US yields remain high.