MM TAX CLUB

This is the first monetary policy statement of 2024, a momentous year for the Reserve Bank of India which enters its 90th year of existence and operations on April 1. Over the years, the Reserve Bank has established itself as a credible institution which stands for stability, trust and economic progress. In recent years, it has become a pioneer in fostering innovation and technology in the financial system. Customer centricity and financial inclusion have always been its priorities. The Reserve Bank’s tireless efforts towards maintaining a fine balance among price stability, financial stability and external sector stability have paid rich dividends as the country embarks on a higher growth trajectory in the years to come. As India gains a pole position in the new global order, the contribution of the Reserve Bank is getting widely recognised in India and abroad.

2. The global economy continues to present a mixed picture. On the one hand, the odds of soft-landing have increased with inflation moving closer to the target and growth holding up better than expected in major advanced and emerging market economies. On the other hand, the ongoing wars and conflicts and the emergence of new flashpoints in different parts of the world, with disruptions in the Red Sea being the latest in the series, impart uncertainty to the global macroeconomic outlook.

3. In this unsettled global environment, the Indian economy has performed remarkably well in the recent years. Growth is accelerating and outpacing most forecasts, while inflation is on a downward trajectory. At the current juncture, India’s potential growth is propelled by structural drivers like improving physical infrastructure; development of world class digital and payments technology; ease of doing business; enhanced labour force participation; and improved quality of fiscal spending. Our multi-pronged, proactive, and calibrated policies on the monetary, regulatory and supervisory fronts have worked well to maintain and strengthen macroeconomic and financial stability.

Decisions and Deliberations of the Monetary Policy Committee (MPC)

4. The Monetary Policy Committee (MPC) met on 6th, 7th and 8th February, 2024. After a detailed assessment of the evolving macroeconomic and financial developments and the outlook, it decided by a 5 to 1 majority to keep the policy repo rate unchanged at 6.50 per cent. Consequently, the standing deposit facility (SDF) rate remains at 6.25 per cent and the marginal standing facility (MSF) rate and the Bank Rate at 6.75 per cent. The MPC also decided by a majority of 5 out of 6 members to remain focused on withdrawal of accommodation to ensure that inflation progressively aligns to the target, while supporting growth.

5. I shall now briefly set out the rationale for these decisions. The momentum in domestic economic activity continues to be strong. Headline inflation, after moderating to 4.9 per cent in October, rose to 5.7 per cent in December 2023. This was primarily due to food inflation, mostly vegetables. The softening in core inflation (CPI inflation excluding food and fuel) continued across both goods and services, reflecting the cumulative impact of monetary policy actions as well as significant softening in commodity prices. The uncertainties in food prices, however, continue to impinge on the headline inflation trajectory.

6. Taking into account this growth-inflation dynamics and the fact that transmission of the cumulative 250 bps policy rate hike is still underway, the MPC decided to keep the policy repo rate unchanged at 6.50 per cent. The MPC will carefully monitor any signs of generalisation of food price pressures which can fritter away the gains in easing of core inflation. Monetary policy must continue to be actively disinflationary to align inflation to the target of 4 per cent on a durable basis. The MPC will remain resolute in this commitment. The MPC also decided to remain focused on withdrawal of accommodation to ensure fuller transmission and anchoring of inflation expectations.

Assessment of Growth and Inflation

Global Growth

7. Global growth is expected to remain steady in 2024 with heterogeneity across regions.¹ Though global trade momentum remains weak, it is exhibiting signs of recovery and is likely to grow faster in 2024². Inflation has softened considerably and is expected to moderate further in 2024.³ Financial markets are volatile as market participants adjust their expectations on the timing and pace of rate cuts by major central banks who remain cautious against premature easing in their fight against inflation.

8. Amidst the current headwinds, elevated level of public debt is raising serious concerns on macroeconomic stability in many countries, including some of the advanced economies (AEs). Global public debt to GDP ratio is projected to reach 100 per cent by the end of this decade. The public debt levels in AEs are in fact much higher than those in the emerging market economies (EMEs).⁴. The challenges of debt sustainability in an environment of high interest rates and low growth at the global level can become new sources of stress. Reducing debt burdens is necessary to create fiscal space for new investments in priority areas, including green transition. As regards India, given the fiscal consolidation path as well as improving growth prospects, we expect the general government debt to gradually come down.⁵

Domestic Growth

9. Domestic economic activity remains strong. The first advance estimates (FAE) placed the real gross domestic product (GDP) growth at 7.3 per cent for 2023-24, marking the third successive year of growth above 7 per cent.⁶

10. Going forward, the momentum of economic activity witnessed during 2023-24 is expected to continue in the next year (2024-25). Agricultural activity is holding up well despite lower rainfall, lower reservoir levels and delayed sowing.⁷ Rabi sowing has surpassed last year’s level as well as the normal acreage.⁸ The allied sector is also expected to provide major support to agriculture with continued momentum in horticulture and fisheries.⁹

11. Industrial activity is gaining steam on the back of improving performance of manufacturing.¹⁰ The early results of corporates in the manufacturing sector remain upbeat, driven by higher profit margins.¹¹ The purchasing managers’ index (PMI) for manufacturing is displaying expansion along with strengthening of future activity index.¹²

12. Services sector activity is expected to remain resilient on the back of strong domestic demand and stable global prospects.¹³ The PMI services increased significantly in January (2024), suggesting continued strong expansion.¹⁴ The buoyant demand for residential housing, coupled with increased thrust on government capex, is expected to propel construction activity.¹⁵

13. On the demand side, improving employment conditions¹⁶ and moderating inflation, together with a rebound in agricultural activity should push up household consumption. Rural demand continues to gather pace.¹⁷ Strengthening farm level activity as reflected in declining MNREGA demand¹⁸ and the extension of Pradhan Mantri Garib Kalyan Anna Yojana (PMGKAY) should further support rural consumption.¹⁹ Urban consumption remains strong on the back of improved income levels.²⁰

14. Investment cycle is gaining steam, aided by sustained thrust on government capex;²¹ increasing capacity utilisation;²² rising flow of resources to the commercial sector;²³ and policy support from schemes such as production linked incentive (PLI).²⁴ Revival in private corporate investment is also underway.²⁵ Our survey suggests that investment intentions of private corporates remain upbeat and both services and infrastructure firms are optimistic about overall business conditions. Net external demand is also improving with narrowing merchandise trade deficit.²⁶ Taking all these factors into consideration, real GDP growth for 2024-25 is projected at 7.0 per cent with Q1 at 7.2 per cent; Q2 at 6.8 per cent; Q3 at 7.0 per cent; and Q4 at 6.9 per cent. The risks are evenly balanced.

Inflation

15. Headline inflation moderated to an average of 5.5 per cent during April-December 2023 from 6.7 per cent during 2022-23. Food price inflation, however, continued to impart considerable volatility to the inflation trajectory.²⁷ In contrast, the deflation in CPI fuel deepened and core inflation (CPI inflation excluding food and fuel) moderated to a four-year low of 3.8 per cent in December. The decline in core inflation continued to be broad based with inflation remaining steady or softening across its constituent groups and sub-groups.²⁸

16. The inflation trajectory, going forward, would be shaped by the outlook on food inflation, about which there is considerable uncertainty. Adverse weather events remain the primary risk with implications for the rabi crop. Increasing geopolitical tensions are leading to supply chain disruptions and price volatility in key commodities, particularly crude oil. On the positive side, the progress in rabi sowing has been satisfactory and augurs well for the season. Prices of key vegetables, especially onions and tomatoes, are registering seasonal price correction. Taking into account these factors, CPI inflation is projected at 5.4 per cent for the current year (2023-24) with Q4 at 5.0 per cent. Assuming a normal monsoon next year, CPI inflation for 2024-25 is projected at 4.5 per cent with Q1 at 5.0 per cent; Q2 at 4.0 per cent; Q3 at 4.6 per cent; and Q4 at 4.7 per cent. The risks are evenly balanced.

What do these Inflation and Growth Conditions mean for Monetary Policy?

17. Inflation has seen a significant moderation from the highs of the summer of 2022. Over the last two years, monetary policy has prioritised inflation over growth, undertaking calibrated increase in policy repo rate by 250 basis points and withdrawal of stimulus measures. Monetary policy was supported by pro-active supply-side measures by the government. That said, the job is not yet finished, and we need to be vigilant about new supply shocks that may undo the progress made so far.

18. Headline inflation has remained high and has seen considerable volatility, moving in a range of 4.3 per cent to 7.4 per cent during the current financial year.²⁹ Recurring food price shocks could interrupt the ongoing disinflation process, with risks that it could lead to de-anchoring of inflation expectations and generalisation of price pressures. Adding to these are the renewed flash points on the geo-political front, including supply chain disruptions. Importantly, the CPI inflation target of 4.0 per cent is yet to be reached. Monetary policy, in the midst of these lingering uncertainties, has to remain vigilant to ensure that we successfully navigate the last mile of disinflation. Stable and low inflation at 4 per cent will provide the necessary bedrock for sustainable economic growth.

Liquidity and Financial Market Conditions

19. After remaining in surplus during April-August 2023, system level liquidity³⁰ turned into deficit from September after a gap of four and half years.³¹ Adjusted for government cash balances, potential liquidity in the banking system is still in surplus. During December-January, the Reserve Bank pro-actively injected liquidity through both the main and the fine-tuning repo operations to ease liquidity tightness in the system.³² With government spending picking up and augmenting system level liquidity, the Reserve Bank undertook six fine-tuning variable rate reverse repo (VRRR) auctions during February 2-7, 2024 to absorb surplus liquidity.³³

20. Financial market segments have adjusted to the evolving liquidity conditions in varying degrees. While the short-term rates have fluctuated, long term rates have remained relatively stable, reflecting better anchoring of inflation expectations as indicated in the softening of term spread in the G-sec market.³⁴ In the credit market, monetary transmission remains incomplete.³⁵

21. Let me reiterate that our policy stance is in terms of interest rate which is the principal tool of monetary policy in the current framework. Our stance of withdrawal of accommodation should be seen in the context of incomplete transmission and inflation ruling above the target of 4 per cent and our efforts to bring it back to the target on a durable basis. So far as liquidity conditions are concerned, these are being driven by exogenous factors, which are likely to correct in the foreseeable future, aided by our market operations. On our part, the Reserve Bank remains nimble and flexible in its liquidity management through two-way main and fine-tuning operations, in both repo and reverse repo. We will deploy an appropriate mix of instruments to modulate both frictional and durable liquidity so as to ensure that money market interest rates evolve in an orderly manner and financial stability is maintained.

22. The reversal of liquidity facilities under both SDF and MSF even during weekends and holidays, announced in our December policy statement, has facilitated better funds management by the banks.³⁶

23. As of February 7, 2024, the Indian rupee (INR) has remained stable compared to both its emerging market peers and a few advanced economies³⁷. In terms of coefficient of variation (CV), the INR exhibited the lowest volatility in 2023-24 (April to January) compared to the corresponding period in the previous three years.³⁸ Let me reiterate that the exchange rate of the Indian rupee is market determined. Its relative stability in the recent period, despite a stronger US dollar and elevated US treasury yields, reflects the strength and stability of the Indian economy, its sound macroeconomic fundamentals, financial stability and improvements in India’s external position, particularly the significant moderation in the current account deficit (CAD), comfortable foreign exchange reserves and return of capital inflows.

Financial Stability

24. The domestic financial system remains resilient with healthy balance sheets of banks and financial institutions.³⁹ The financial parameters of non-banking financial companies (NBFCs) are also improving in tandem with those of the banking system.⁴⁰ Good governance, robust risk management, sound compliance culture and protection of customers’ interest are of paramount importance for the safety and stability of the financial system and individual institutions. The Reserve Bank lays great emphasis on these aspects. We expect all regulated entities to accord the highest priority to these functions.

External Sector

25. India’s current account deficit (CAD) declined sharply to 1.0 per cent of GDP in Q2:2023-24 from 3.8 per cent in Q2:2022-23. Going ahead, the net balance under services and remittances is expected to remain in large surplus, partly offsetting the trade deficit. India’s services exports remained resilient in October-December 2023, driven by software, business and travel services.⁴¹ Moreover, with around 10.2 per cent share in world telecommunications, computer and information services exports, India is a significant player in the world software business.⁴² According to the World Bank, with an estimated US$135 billion in inward remittances in 2024, India would remain the largest recipient of remittances globally.⁴³ Thus, the CAD for 2023-24 and 2024-25 is expected to be eminently manageable.

26. On the financing side, net foreign direct investment (FDI) stood at US$ 13.5 billion in April-November 2023 as compared with US$ 19.8 billion a year ago.⁴⁴ Foreign portfolio investment (FPI) witnessed a sharp turnaround during 2023-24 (up to February 6) with net FPI inflows of US$ 32.4 billion as against net outflows of US$ 6.7 billion a year ago. Net accretions to non-resident deposits and net inflows under external commercial borrowings were also higher during the year.⁴⁵ As on February 2, 2024, India’s foreign exchange reserves stood at US$ 622.5 billion.⁴⁶ Vulnerability indicators suggest greater resilience of India’s external sector.⁴⁷ We are confident of comfortably meeting all our external financing requirements.

Additional Measures

27. I shall now announce certain additional measures.

Review of the Regulatory Framework for Electronic Trading Platforms (ETPs)

28. The Reserve Bank’s extant regulatory framework for electronic trading platforms (ETPs) was issued in 2018. In view of the subsequent developments in markets, products, and technology, etc., a revised regulatory framework for ETPs will be issued for stakeholders’ feedback.

Hedging of Gold Price Risk in the Over the Counter (OTC) Market in the International Financial Services Centre (IFSC)

29. In December 2022, the Reserve Bank had permitted resident entities to hedge their gold price risk in recognised exchanges in the IFSC. It has now been decided to also allow resident entities to hedge the price of gold in the over the counter (OTC) segment in the IFSC. This will provide more flexibility to resident entities in hedging their exposure to gold prices.

Key Fact Statement (KFS) for Retail and MSME Loans & Advances

30. At present, the loans and advances availed by borrowers, apart from including the rate of interest, also include other fees and charges such as processing fees, documentation charges, etc. To enhance transparency in disclosure of such information, the Reserve Bank had mandated certain categories of lenders to provide the borrower a Key Fact Statement (KFS) containing essential information such as the all-inclusive annual percentage rate (APR) and recovery and grievance redress mechanism. The requirement of KFS is now being extended to cover all retail and MSME loans. This measure will lead to enhanced transparency in lending and enable customers in making informed decisions.

Enhancing the Robustness of AePS

31. Aadhaar Enabled Payment System (AePS) has played an important role in financial inclusion by enabling customers to make digital payment transactions through service providers such as business correspondents. Given their significance, it is proposed to streamline the process for on-boarding of AePS service providers and introduce some additional fraud risk management measures. These measures will further strengthen the security of the AePS system and enhance its robustness.

Principle-Based Framework for Authentication of Digital Payment Transactions

32. Over the years, the Reserve Bank has proactively facilitated introduction of various mechanisms such as Additional Factor of Authentication (AFA) for securing digital payments. While no particular mechanism was specified by the Reserve Bank, SMS-based OTP has become very popular. With technological advancements, however, alternative authentication mechanisms have emerged in recent years. Therefore, to facilitate adoption of alternative authentication mechanisms for enhancing the security of digital payments, it is proposed to put in place a principle-based framework for authentication of such transactions.

Introduction of Programmability and Offline Functionality in Central Bank Digital Currency (CBDC) Pilot

33. The CBDC Retail (CBDC-R) pilot currently enables Person to Person (P2P) and Person to Merchant (P2M) transactions. It is now proposed to enable additional functionalities of programmability and offline capability in CBDC retail payments. Programmability will facilitate transactions for specific/targeted purposes, while offline functionality will enable these transactions in areas with poor or limited internet connectivity.

Conclusion

34. The Indian economy is making confident progress on a strong, sustained and transformative growth path. Domestic and international investors are reposing greater confidence on India’s economic prospects. In our assessment, the current setting of monetary policy is moving in the right direction with growth holding firm and inflation trending down to the target. Therefore, much has been achieved, but we must remain vigilant. Policymaking during uncertain times has to be based on a continuous assessment of the incoming data and its implications for the evolving outlook.

35. We reaffirm our commitment to bring down inflation to the target of 4 per cent in a timely and sustainable manner. Price and financial stability are the foundations for strong, sustainable and inclusive growth. Our endeavour all along has been to take a holistic approach to keep the economy in balance. We must not only preserve the hard-earned strength and stability of the Indian economy but also build on this further for a long haul of higher growth with price and financial stability. In the current environment, what Mahatma Gandhi said long ago remains relevant and I quote: “I am moving cautiously, watching myself at every step. ….. but there is the fixed determination behind every act of mine

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