Monetary Policy Changes Effectively Guiding Market Expectations Amid Signs Of Global Economy Slowing Down, Says RBI Bulletin

The global economy has shown signs of slowing down in the final quarter of 2023 with manufacturing languishing, while services sector activity appears to have reached the end of its post-pandemic expansion. Elsewhere, the unanticipated changes in policy rate or monetary policy suggests that the Reserve Bank of India’s (RBI) communication has been effective in guiding market expectations, while the external benchmark-based lending rate (EBLR) system of loan pricing, calibrated normalisation of surplus liquidity and robust credit growth has strengthened transmission during the current tightening phase although it was still not complete.

All this and more form the gist of RBI’s November issue of its monthly bulletin, released on November 16, 2023, covering articles and statistics on the state of the economy, monetary policy and on decoding money policy expectations from financial data.

State Of The Economy

The article titled State Of The Economy says that the tightening financial conditions has been a significant risk to the global outlook, and in India, the momentum of the change in gross domestic product is sequentially expected to be higher in Q3:2023-24, with festival demand remaining ebullient.

According to the article, the investment demand also appears to be resilient with the government’s infrastructure spending, an uptick in private capex, automation, digitalisation, and indigenisation providing a boost. “Headline inflation came down to 4.9 per cent in October from the average of 6.7 per cent in 2022-23 and 7.1 per cent in July-August 2023,” the article said.

Monetary Policy Transmission In India

The bulletin also featured another article titled Monetary Policy Transmission In India: Recent Dynamics’ Reviewing The Recent Monetary Policy Transmission Dynamics In India.

The article said that the external benchmark-based lending rate (EBLR) system of loan pricing, calibrated normalisation of surplus liquidity and robust credit growth had strengthened transmission during the current tightening phase although it was still not complete.

“The transmission to term deposit rates has been strong, while savings deposit rates have remained largely unchanged. Therefore, the pace of increase in deposit rates (term deposits and savings account deposits taken together) has lagged the pace of increase in lending rates in the current tightening cycle, which is reflected in an improvement in the net interest margins (NIMs) of banks during 2022-23,” it said.

According to the article, an empirical bank-level analysis in a panel framework indicates that surplus liquidity in the banking system and a higher share of current account savings account (CASA) deposits in total deposits has a softening impact on lending rates. The pass-through to lending rates is found to be higher during the tightening cycle.

“High credit-deposit (CD) ratio raises deposit and lending rates. Surplus liquidity and excess SLR lower the pass-through to deposit rates,” the article added.

Reading The Market’s Mind The bulletin also featured an article titled Reading The Market’s Mind: Decoding Monetary Policy Expectations From Financial Data. The article used the overnight index swaps (OIS) rate to decode the near-term market expectations of changes in the monetary policy rate during 2016-2023. The article also analysed the impact of anticipated and unanticipated changes in the policy rate on interest rates across market segments and maturities. According to the article, during 2016-2023, unanticipated changes in policy rate or monetary policy surprises were rare, which suggested that the RBI’s communication has been effective in guiding market expectations. “The anticipated changes in policy rate are found to have no immediate impact on longer term interest rates as those were already factored in by the markets. In contrast, the few instances of monetary policy surprises had an instantaneous impact across market segments and maturities on the day of the policy announcement,” the article added.