RBI Monetary Policy August 2023 received via priority account.... Just sharing...
RBI Monetary Policy
August 2023
Highlights
MPC holds rates as expected and
signals a readiness for further action if inflation persists.
MPC’s third bi-monthly Monetary Policy Review: 202324:
The MPC has unanimously voted to keep the policy rate unchanged.
Their stance on focusing of withdrawal of accommodation is also retained with continued emphasis on the 4% inflation target and potential for further action if inflation becomes persistent.
Policy Actions
Repo rate maintained at 6.50%.
Consequently, SDF is at 6.25% and MSF is at 6.75%.
RBI has kept CRR unchanged at 4.50%.
A 10% incremental CRR on increase in NDTL between 19th
May’23 and 28th Jul’23 to take out ~1 tn liquidity out of the system, with review on 8th Sep’23.
Growth-Inflation dynamics
For FY24, inflation projection is revised upwards to 5.4% (from 5.1% earlier), with sharp moves in Q2FY24 on account of a sizeable pick up in vegetable prices.
The MPC acknowledged improvement in the progress of monsoon and Kharif sowing as well as correction in vegetable prices with fresh arrivals. However, there are concerns around potential generalization of multiple inflation shocks were noted with risks also arising from oil prices and higher output inflation.
For FY24, the real GDP growth was retained at 6.5% with robust urban demand and recovering rural demand. Apart from this, weak external demand, geopolitical tensions and volatility in financial markets were seen among downside risks.
Buoyancy in services, strong core IIP, higher e-way bills and toll collections as well as recovery in rail freight and port traffic seen auguring well for overall economic activity this year. Moderation in PV and 2-wheeler sales growth was also noted along with slowing external demand.
Liquidity & External Sector
RBI introduced an incremental CRR of 10% on the increase in NDTL between 19th May’23 and 28th Jul’23 given muted response to VRRR and lower desirability of SDF as an operative rate. This is estimated to withdraw around 1 trillion INR from the system and bring liquidity conditions closer to normal.
Lower merchandise imports and strong services exports feature in narrowing CAD expectations. Language on FX reserves continues to express confidence.
Policy Stance & Guidance
There is a shift in language towards potential action if multiple shocks were to make inflation more persistent.
There is emphasis on action being earlier on rates front but also through other tools.
Key measures announced by RBI
Measures announced in chronological order in last 1 year.
Date Measures Announced
August 5, 2022 • Proposed to enable Standalone Primary Dealers (SPDs) to offer all foreign exchange market-making facilities as currently permitted to Category-I Authorised Dealers, subject to prudential guidelines.
• SPDs will be permitted to undertake transactions in the offshore Rupee Overnight Indexed Swap (OIS) market with non-residents and other market makers.
• Enabling Bharat Bill Payment System (BBPS) to Process Cross-Border Inbound Bill Payments
• Inclusion of Credit Information Companies (CICs) under the Reserve Bank-
Integrated Ombudsman Scheme (RB-IOS) 2021 and Introduction of the Internal Ombudsman (IO) Mechanism
• Proposed to set up a committee to undertake an in-depth examination of the issues, including the need for transition to an alternative benchmark for MIBOR, and suggest the way forward.
September 30, 2022 • Discussion Paper on Expected Loss (EL) Based Approach for Loan Loss Provisioning by Banks
• Discussion Paper on Securitisation of Stressed Assets Framework (SSAF)
December 7, 2022 • Banks will now be allowed to include securities acquired between Sept 1, 2020 and Mar 31, 2024. The HTM limits would be restored from 23% to 19.5% in a phased manner starting from the quarter ending June 30, 2024.
• The capabilities in UPI will be further enhanced by introducing single-block-andmultiple-debits functionality.
• With a view to providing greater flexibility, resident entities will now be permitted to hedge their gold price risk on recognised exchanges in the IFSC.
February 8, 2023 • Regulated Entities (REs) are required to have a policy for levy of penal interest on advances.
• Decided to issue guidelines for REs on
i. a broad framework for acceptance of Green Deposits; ii. disclosure framework on Climate-related Financial Risks; and iii.guidance on Climate Scenario Analysis and Stress Testing.
• Proposed to expand the scope of TReDs by
i. providing insurance facility for invoice financing;
ii. permitting all entities/institutions undertaking factoring business to participate as financiers in TReDS; and
iii.permitting rediscounting of invoices (that is, developing a secondary market in TReDS).
• These measures are expected to improve the cash flows of the MSMEs.
• Launch a pilot project on QR Code based Coin Vending Machine in 12 cities.
Key measures announced by RBI
Measures announced in chronological order in last 1 year.
Date Measures Announced
April 6,
2023 • Proposed to permit banks with IFSC Banking Units (IBUs) to offer nondeliverable foreign exchange derivative contracts (NDDCs) involving INR to resident users in the onshore market.
• To develop a web portal to enable search across multiple banks for possible unclaimed deposits.
• Proposed to expand the scope of UPI by permitting operation of pre-sanctioned credit lines at banks through the UPI.
June 8,
2023 • Allowing issuance of RuPay prepaid forex cards, also enabled for issuance in foreign jurisdictions.
• Rationalising licensing framework for Authorised Persons (AP) under FEMA, last revised in 2006.
• Extension of timelines by another 2 years up to March 2026 for achieving the targets of Priority Sector Lending (PSL) for Primary (Urban) Cooperative Banks (UCBs).
• Proposed to issue comprehensive guidelines on compromise settlements and technical write-offs which will now be applicable to all regulated entities including co-operative banks.
• Decided that SCBs (excluding Small Finance Banks) can set their own limits for borrowing in Call and Notice Money Markets within the prescribed prudential limits for inter-bank liabilities to provide greater flexibility for managing their liquidity.
• Allowing PPI issuers to issue e-RUPI vouchers, and enabling issuance of vouchers on behalf of individuals
August 10, 2023 • To revise the extant regulations issued in June 2019 and put in place a comprehensive, risk-based framework for administration of financial benchmarks.
• Consolidation and harmonization of instructions for Supervisory data submission
• Public tech platform for seamless delivery of credit and digital information, banks can plug and play
• UPI: Conversational payments, offline payments, and higher limit for small value payments
• Users to be able to pay in conversation with AI-powered system
• Offline transactions on UPI-Lite system through near-field communications
• Transaction limit of Rs. 200 raised to Rs. 500 for small value digital payments in offline mode
• Transparency in interest rate reset of EMI based floating rate loans
• Clear communication on changes, available options including converting to a fixed rate, and schedule of fees
• NBFC-infrastructure debt funds – easing of regulatory framework
• Withdrawal of requirement for sponsor
• Permission to finance toll-operate-transfer projects as direct lenders
• Access to ECBs
• Making tri-partite agreements optional for PPP projects
Impact on the Mutual Fund Industry
Liquid Funds:
These schemes will continue to generate returns around the operating rate due to their portfolio composition i.e. being invested at the shorter end of the money market segment. Liquid funds have low average maturity as they concentrate more on high quality papers including CPs, CDs and other debt securities with residual maturity of upto 3 months.
Ultra Short Term / Low Duration / Money Market Funds (Maturity Up to 1 Year):
These schemes predominantly invest in below 1 year maturity paper. The strategy adopted by these schemes is to hold the paper till maturity and capitalize on the running yield. Hence, returns in this category will continue to remain relatively attractive depending on the positioning of the fund.
Short Duration Funds:
Schemes in this category are predominantly invested in Corporate Bonds, CPs and CDs while a few of them also have some exposure to G-Secs. We continue to remain bullish at the shorter end of the curve. Investors may consider these funds (with an investment horizon commensurate with the maturity profile of such funds) and gain from current accruals and capital appreciation in the event of a fall in yields.
Medium Duration:
Given the flattened yield curve there are sufficient buffers in the intermediate duration (3-6 years) segment. Till the time RBI is anchoring the long end of the yield curve, the current yield curve may provide some cushion even if there are mark-to-market losses. Investors may consider those funds with high quality portfolios and where the investment horizon is commensurate with the maturity profile of the funds and also gain from current accruals and capital appreciation in the event of a fall in yields.
Credit Risk Funds:
We remain cautious on Credit Risk Funds as they have failed to prove their mettle in the last 2-3 years with the overhang of defaults and erosions of NAV on the back of mark-to-market impacts due to the aforementioned. The uncertainty around credit funds which are in an open ended avatar continues to pose risks to investors. Much also depends on the liquidity conditions in the market and redemption pressure on these funds. Thus, we think there is a systemic risk in the market within the credit space. Hence, it makes sense for one to stay away from these funds.
Impact on the Mutual Fund Industry
Long Term Income Funds / Gilt Funds / Dynamic Bond Funds:
The RBI, in today’s monetary policy meeting, held repo rate at 6.50% which was unchanged for the third consecutive time and maintained its stance on focus of withdrawal of accommodation. This pause on rate hikes is aimed at financial stability and future course of action shall be data dependent. The 10-year benchmark yield continued to trend upwards for the second consecutive month on fears of an elongated period of high interest rates. The yields closed at 7.15% down by 2 bps. Indian bond yields and U.S. yields are on a rise. Markets believe that the rate hikes from the Fed are near its peak thus shifting their focus to domestic factors such as the upcoming supply of debt, as well as concerns over domestic inflation that will keep yields at elevated levels.
In month of July, the US Federal Reserve and the European Central Bank (ECB) had increased rates by 25 basis points to 5.25-5.5% and 3.75%, respectively, the highest level since 2001. The US treasury yields inched higher after Fed Chair Jerome Powell said that the U.S. central bank has not ruled out raising rates in consecutive meetings as the economy still needed to slow down and the labor markets to weaken for inflation to "credibly" return to the U.S. central bank's 2% target. The FOMC will be assessing “the totality of the incoming data” as well as the implications for economic activity and inflation for any future course of action.
Domestically, the RBI left its growth forecast for the Indian economy unchanged while raised inflation projections to 5.4%, with significant revision to Q2FY24. This was due to lingering worries about retail inflation inching up owing to the recent spike in prices of essential food items. Monsoon rains are now in surplus but there is a big quantitative-qualitative gap. The monsoon has reached an overall surplus of 5% as on 24th July following an initial heavy deficit. Quality of this surplus is very low due to heavy spatial and temporal skews which retard cropping output. Kharif coverage, though overall strong, hides the darker side of damage caused due to heavy rains. Additionally, after the Black Sea grain deal being halted by Russia, India could see an impact on food that can drive inflation higher.
Impact on the Mutual Fund Industry
Indian bond yields are expected to trade with an upward bias given the global yields continue to inch upwards. Market participants await new debt supply and are staying cautious amidst rising inflation concerns. This is likely to weigh on MPC when it meets next week. From a global perspective, elevated crude prices, along with a rise in US bond yields shall add upward pressure on bond yields. However, probabilities for further hikes are limited globally as well as in India. Though US Fed has left the door open for one more hike, market participants believe that the Federal Reserve's rate hiking cycle is done. The 10-year benchmark yields may continue to be volatile over the next few months and are likely to oscillate in a tight range as uncertainty looms. We believe the 3 to 6 years segment appears to be in a sweet spot from a risk-reward perspective with the quality approach on bonds as the risks on inflation prevails. Liquidity conditions are expected to remain tight which is likely to keep interest rates at the shorter end high while the longer end may be anchored.
Conservative Hybrid Funds-CHF (Erstwhile: Monthly Income Plans (MIPs):
With between 10% to 25% allocation to equity, returns of CHFs are largely determined by the vagaries of the equity markets as against the debt markets. These funds are therefore suitable for investors who have a reasonably long time horizon & are comfortable with taking exposure to equities.
Outlook
With more action oriented language which is coupled with unease around generalization of inflation, are indications for further room of action. Market pricing has already begun to indicate the possibility of one more rate hike. However, the current balance of probabilities indicate a hold, but risks of another hike are no longer trivial.
We remain constructive on the short to medium end of the yield curve. Short Duration funds, Banking & PSU Debt funds, Corporate Bond funds, Debt Index funds (Target Maturities), Medium Duration funds, Floating Rate funds, Money Market funds, Low Duration funds and Ultra Short Duration funds can be considered by investors with an investment horizon commensurate with the maturity profile of the schemes. Investors can consider investing in Medium/Long Duration funds as per their risk appetite with an investment horizon of at least 2-3 years to avoid any intermittent volatility.
