Reserve Bank of India Annual Report 2023-24 PDF

THE ANNUAL REPORT ON THE WORKING MONETARY OF THE RESERVE BANK OF INDIA POLICY OPERATIONS PART TWO: THE WORKING AND OPERATIONS OF...

THE ANNUAL REPORT ON THE WORKING MONETARY OF THE RESERVE BANK OF INDIA POLICY OPERATIONS PART TWO: THE WORKING AND OPERATIONS OF THE RESERVE BANK OF INDIA III MONETARY POLICY OPERATIONS With the cumulative interest rate increases of 250 basis points (bps) undertaken in 2022-23, headline inflation moderated and moved into the tolerance band during 2023-24 amidst intermittent food price spikes even as economic activity exhibited resilience. The monetary policy committee (MPC) kept the policy repo rate unchanged and maintained the stance of withdrawal of accommodation through 2023-24. The pace of transmission to banks’ deposit and lending rates moderated. Liquidity conditions evolved in sync with the monetary policy stance. III.1 During 2022-23, the monetary policy firmed up. Long-term yields remained broadly committee (MPC) increased the policy repo rate stable. The Reserve Bank conducted two-way by cumulative 250 bps. The impact of the increase liquidity operations. The transmission of policy in the repo rate and softening input cost pressures rate increases of 2022-23 to banks’ deposit and was reflected in a steady decline in core consumer lending rates continued although its pace slowed price index (CPI) inflation (CPI excluding food and during the course of the year. fuel). CPI headline inflation also eased into the III.3 Against the above backdrop, section 2 tolerance band, although transient shocks from presents the implementation status of the agenda vegetable prices pushed it occasionally above the set for 2023-24 along with major developments upper tolerance threshold. Disinflation costs were during the year, while section 3 sets out the minimised by the resilience of domestic economic agenda for 2024-25. Concluding observations are activity in spite of formidable global headwinds. provided in the last section. Accordingly, the MPC maintained status quo on 2. Agenda for 2023-24 the policy repo rate and persevered with a stance of withdrawal of accommodation during 2023-24. III.4 The Department had set out the following goals for 2023-24: III.2 During the year, liquidity conditions evolved in line with the monetary policy stance. Application of machine learning (ML) An incremental cash reserve ratio (I-CRR) was techniques for improving nowcasting and applied as a temporary measure during August 12 forecasting of gross domestic product to October 7, 2023 to absorb the surplus liquidity (GDP) [Utkarsh 2.0] (Paragraph III.5); resulting from the return of ₹2000 banknotes to Strengthening the analysis of transmission the banking system. With system liquidity turning to lending rates of non-banking financial into a deficit in H2 on account of the build-up of companies (NBFCs) and sectoral lending government cash balances and festival related by them (Utkarsh 2.0) [Paragraph III.5]; currency outgo, short-term money market rates and 81  ANNUAL REPORT 2023-24 A review of the working of the external 5.7 per cent in December 2022 amidst high inflation benchmark system for loans in monetary in several food sub-groups. The outlook for inflation policy transmission (Utkarsh 2.0) remained uncertain in the backdrop of unseasonal [Paragraph III.5]. rains and hailstorms, the lagged pass-through of input costs pressures into output prices, global Implementation Status financial market volatility and imported inflation III.5 The nowcasting and forecasting models risks, especially from crude oil prices. Assuming used for short-term projections of GDP were an annual average crude oil price (Indian basket) augmented by employing linear and non-linear ML at US$ 85 per barrel and a normal monsoon, CPI techniques using high frequency indicators. Data inflation was projected at 5.2 per cent for 2023-24, on transmission and sectoral deployment of credit with Q1 at 5.1 per cent, Q2 at 5.4 per cent, Q3 at 5.4 from major NBFCs are being collected and efforts per cent and Q4 at 5.2 per cent, with risks evenly are underway to streamline the data submission balanced. Real GDP growth for 2023-24 was process under the centralised information projected at 6.5 per cent, underpinned by a good management system (CIMS). A detailed review rabi crop, sustained buoyancy in contact-intensive of the external benchmark-based lending rate services, the government’s thrust on capex, and (EBLR) system was conducted. Feedback and double digit credit growth. The MPC unanimously suggestions have been received from banks. decided to keep the policy repo rate unchanged at 6.50 per cent in April 2023 after six sequential III.6 Studies were carried out during the year rate hikes during 2022-23. The MPC emphasised (i) to assess properties of various core inflation that it would continue to keep a strong vigil on the measures in view of recurrent inflation shocks evolving inflation and growth outlook and take in recent years; (ii) to gauge the impact of the further action, if required. The MPC also decided to surge in digital payments on currency demand; remain focused on withdrawal of accommodation (iii) to extract expectations on the policy rate from to ensure that inflation progressively aligns to the the 2-month overnight index swaps (OIS); (iv) to target while supporting growth, with a 5-1 vote. evaluate the operation of the standing deposit III.8 With inflation dipping into the tolerance facility (SDF) after one year of its introduction; band during March-April 2023, under the (v) to compare monetary transmission in the combined impact of monetary tightening and current tightening cycle vis-à-vis the previous supply augmenting measures, and domestic easing phase; and (vi) to examine the pass- activity remaining resilient, the MPC maintained through of input prices to output prices in a status quo on policy rate by a unanimous decision cross-country framework. and maintained the stance with a 5-1 vote in its Major Developments June 2023 meeting. It noted that the cumulative rate hike of the past was still transmitting through Monetary Policy the economy and its fuller impact should keep III.7 When the MPC met for its first meeting inflationary pressures contained in the coming of 2023-24 in April, CPI headline inflation had months. The MPC resolved to take further accelerated to 6.4 per cent in February 2023 from monetary actions, as required, to keep inflation 82  MONETARY POLICY OPERATIONS expectations firmly anchored and to bring down persistence. It noted that with headline inflation inflation to the target. above the tolerance band, monetary policy needed to remain actively disinflationary. The III.9 When the MPC met in August 2023, the MPC unanimously decided to keep the policy repo global economy was slowing with divergent rate unchanged at 6.50 per cent while retaining its growth trajectories across regions. Inflation was stance with a 5-1 vote. moderating but ruled above the target. Tight financial conditions, simmering geopolitical III.11 By the time the MPC met in December conflicts and geoeconomic fragmentation were 2023, domestic economic activity had maintained the main risks. Domestic CPI inflation picked up resilience, underpinned by robust investment and from 4.3 per cent in May to 4.8 per cent in June, government consumption. The projection of real driven largely by price pressures in food items, GDP growth for 2023-24 was increased to 7.0 most prominently in tomatoes. The uneven south- per cent. CPI headline inflation fell by about 2 west monsoon, upward pressures on global food percentage points to 4.9 per cent in October on prices due to the hostile geopolitical environment sharp correction in prices of certain vegetables, and hardening crude oil prices on production cuts deflation in fuel and a faster and broad-based posed risks to the inflation outlook. Considering disinflation in core prices. The CPI inflation forecast these factors and assuming a normal monsoon, was retained at 5.4 per cent for 2023-24, with Q3 the CPI inflation forecast was revised up to 5.4 at 5.6 per cent; and Q4 at 5.2 per cent. Assuming per cent for 2023-24, with Q2 at 6.2 per cent, Q3 a normal monsoon for 2024-25, CPI inflation for at 5.7 per cent and Q4 at 5.2 per cent, with risks Q1:2024-25 was projected at 5.2 per cent; Q2 at evenly balanced. With the repo rate increases 4.0 per cent; and Q3 at 4.7 per cent. The MPC still working their way into the economy, the MPC unanimously decided to keep the policy repo rate unanimously decided to keep the policy repo rate unchanged at 6.50 per cent with readiness to take unchanged at 6.50 per cent with preparedness to appropriate policy actions as and when required undertake policy responses, should the situation and retained its stance with 5-1 vote. so warrant. The MPC also reiterated its stance of III.12 Against the backdrop of continued withdrawal of accommodation with a 5-1 vote. momentum in economic activity, the MPC in its III.10 At the time of the October 2023 meeting, February meeting projected real GDP growth for global growth was losing momentum but domestic 2024-25 at 7.0 per cent. CPI inflation had picked real GDP had registered robust growth in up in November and December, primarily on Q1:2023-24. CPI headline inflation, after surging account of vegetable price increases, even as fuel by 2.6 percentage points to 7.4 per cent in July deflation deepened and core inflation softened due to a spike in vegetable prices, moderated to to a four year low of 3.8 per cent in December 6.8 per cent in August. Core inflation continued 2023. CPI inflation was projected at 5.4 per cent its descent in July-August. The MPC observed for 2023-24 with Q4 at 5.0 per cent. Assuming a that the unprecedented food price shocks were normal monsoon, CPI inflation for 2024-25 was impinging on the evolving trajectory of inflation projected at 4.5 per cent with Q1 at 5.0 per cent; and the recurring incidence of such overlapping Q2 at 4.0 per cent; Q3 at 4.6 per cent; and Q4 at shocks could impart generalisation and 4.7 per cent, with risks evenly balanced. While 83  ANNUAL REPORT 2023-24 Chart III.1: Monetary Policy Committee (MPC) Voting Pattern a: Voting on Repo Rate b: Voting on Monetary Policy Stance 6 7 6 Number of MPC members Number of MPC members 6.5 5 5 6.5 6.5 6.5 6.5 6.5 6.5 6.5 6 Policy repo rate 4 6.25 4 5.9 5.5 3 5.4 5 3 4.9 4.5 2 2 4.4 4 1 1 4 3.5 0 3 0 Apr-22 May-22 Jun-22 Aug-22 Sep-22 Dec-22 Feb-23 Apr-23 Jun-23 Aug-23 Oct-23 Dec-23 Feb-24 Apr-22 May-22 Jun-22 Aug-22 Sep-22 Dec-22 Feb-23 Apr-23 Jun-23 Aug-23 Oct-23 Dec-23 Feb-24 Monetary policy meetings Monetary policy meetings (-) 25 Basis Points Pause (+) 25 Basis Points Accommodative with Focus on Withdrawal of Accommodation (+) 35 Basis Points (+) 40 Basis Points (+) 50 Basis Points Withdrawal of Accommodation Neutral Repo Rate (RHS) Different Stance (Dissent/Reservation) Source: RBI. domestic activity was holding up well, large and The MPC also decided to remain focused on repetitive food price shocks were interrupting the withdrawal of accommodation with a 5-1 vote. pace of disinflation. The MPC decided to keep the III.13 The MPC’s decisions during 2023-24 policy repo rate unchanged at 6.50 per cent with were marked by unanimity on rate actions barring a 5-1 vote to sustain the path of disinflation. The the February meeting, but diversity in stance MPC noted that monetary policy must continue (Chart III.1). to be actively disinflationary to ensure anchoring III.14 Globally, many central banks have kept of inflation expectations and fuller transmission. rates on hold since mid-2023 (Table III.1). Table III.1: Policy Rates – Major Central Banks III.15 Monetary policy communication has Category Country Policy Rate Pause Since gained prominence in anchoring expectations of (per cent) (As on March economic agents (Box III.1). 31, 2024) The Operating Framework: Liquidity Management 1 2 3 4 US 5.50 July 2023 III.16 In consonance with the monetary policy UK 5.25 August 2023 stance, liquidity management operations during Euro Area 4.50 September 2023 AEs 2023-24 were aimed at balancing out the level Canada 5.00 July 2023 Sweden 4.00 September 2023 of liquidity in the banking system. Keeping in New Zealand 5.50 May 2023 view the increase in surplus liquidity due to India 6.50 February 2023 various factors (discussed below), the Reserve EMEs Thailand 2.50 September 2023 Bank imposed an incremental cash reserve Malaysia 3.00 May 2023 ratio (I-CRR) of 10 per cent on the increase South Africa 8.25 May 2023 in net demand and time liabilities (NDTL) of all US: United States. UK: United Kingdom. AEs: Advanced Economies. EMEs: Emerging Market Economies. scheduled banks between May 19 and July 28, Source: Central banks’ websites. 2023, effective from the fortnight beginning 84  MONETARY POLICY OPERATIONS Box III.1 Monetary Policy Communication in India Communication is an important strategy of central banks Chart 1: Topic Evolution which fosters transparency and credibility of their policy Topic proportions (per cent) 12.2 16.2 announcements. The Reserve Bank’s communication on 13.7 20.8 16.2 monetary policy includes the MPC’s resolutions, minutes of 8.7 11.5 13.5 the MPC’s meetings, Governor’s statement, the Monetary 31.1 0.9 31.3 Policy Report (MPR), press conferences on the day of 31.5 announcement of the policy and the speeches delivered on 34.3 36.5 21.6 various occasions. Pre-COVID COVID to Pre-War Post-War An analysis of MPC’s resolutions using natural language Inflation Financial Markets Liquidity Monetary Policy Growth External COVID processing (NLP) techniques shows that the emphasis of Note: 1. Latent Dirichlet Allocation (LDA) method has been used for topic communication varied, depending on situations; seven modelling. 2. Topic labelling is based on prominent words within a topic. key topics emerged during October 2016 to October Source: RBI staff estimates. 2023 (Chart 1). Inflation remained as the central topic of The impact of the weighted average call rate (WACR) [which discussion, followed by growth during the pre-COVID-19 mirrors changes in the policy repo rate], communication tone period (October 2016 to February 2020). This sequence, on inflation (MPC_INF) and growth (MPC_GR) is assessed however, reversed during the pandemic (March 2020 to on the overnight index swap (OIS) rates in an event- February 2022); liquidity and COVID topics also received study approach (a five-day window before and after policy attention. The geopolitical crisis in 2022 and the resultant announcement). The analysis suggests that the WACR inflationary pressures shaped subsequent MPC discussions drives short-term OIS rates, but its influence decreases with inflation returning as the core topic (March 2022 as the tenor increases (Table 1). The OIS rates exhibit a to October 2023); the focus on external linkages also weak and insignificant correlation with communication increased. tone on growth. Conversely, they have significant inverse As communication can supplement quantitative changes relationship with inflation tone. Further, communication in the policy repo rate and impact financial markets, on inflation matters more during policy tightening phases communication tone of monetary policy was used for (Table 2). analysis1. Communication tone on inflation resonated An analysis of inflation outlook of professional forecasters well with the policy cycle; during the tightening period, the reveals that both inflation projections (quantitative) and tone was negative, while it was positive during the easing inflation tone influence their forecasts. When projection cycle. The tone on growth remained positive or negative, is lower and the tone is positive, moderation is seen in depending on prevailing economic conditions. professionals’ forecasts and vice versa (Table 3). Table 1: Impact of Communication on OIS Rates Item OIS_1M OIS_2M OIS_3M OIS_6M OIS_9M OIS_1Y 1 2 3 4 5 6 7 WACR 0.484*** 0.373*** 0.327*** 0.279* 0.287* 0.290* MPC_INF -0.102 -0.112 -0.144 -0.199* -0.218* -0.237* Constant -0.032 -0.016 -0.012 -0.006 -0.003 0.001 *** and * indicate significance levels at 1 per cent and 10 per cent, respectively. Note: The analysis covers data from April 2018 to October 2023. Source: RBI staff estimates. (Contd.) 1 For communication tone, customised dictionary consisting of hawkish-dovish words for inflation and expansionary-contractionary words for growth has been used. 85  ANNUAL REPORT 2023-24 Table 2: Impact of Communication on OIS Rates - Different Policy Cycles Item OIS_1M OIS_2M OIS_3M OIS_6M OIS_9M OIS_1Y 1 2 3 4 5 6 7 WACR 0.401*** 0.261* 0.213 0.136 0.157 0.147 MPC_INF_Easing -0.199 -0.232 -0.219 -0.179 -0.163 -0.197 MPC_INF_Tightening -0.239 -0.306* -0.391** -0.639*** -0.657*** -0.698*** MPC_INF_Status quo -0.040 -0.029 -0.057 -0.081 -0.108 -0.118 Constant -0.032 -0.016 -0.018 -0.028 -0.027 -0.023 ***, ** and * indicate significance levels at 1 per cent, 5 per cent and 10 per cent, respectively. Source: RBI staff estimates. Overall, the analysis suggests that effective communication References: can shape the expectations of economic agents. 1. Blinder, A. S., Ehrmann, M., Fratzscher, M., De Haan, J., & Jansen, D. J. (2008), ‘Central Bank Communication Table 3: Impact of Communication on Inflation Outlook and Monetary Policy: A Survey of Theory and Evidence’, of Professional Forecasters Journal of Economic Literature, 46 (4), 910-945. Item INF_Outlook 2. Das, Shaktikanta (2022), ‘Monetary Policy and Central Bank Communication’, Speech at the National Defence 1 2 College, Ministry of Defence, Government of India, New Inflation 0.731*** Delhi, March 4. MPC_INF 0.340 INF_projection_1# -0.156** 3. Patra, M. D. (2022), ‘The Lighter Side of Making INF_projection_2 & 0.047* Monetary Policy’, Speech at the 9th SBI Banking and Constant 1.422*** Economics Conclave, Mumbai, November 24. #: MPC_INF tone is positive and INF projection below 5 per cent. 4. Lagarde, C. (2023), ‘Communication and Monetary &: MPC_INF tone is negative and INF projection above 5 per cent. ***, ** and * indicate significance levels at 1 per cent, 5 per cent Policy’, Speech at the Distinguished Speakers Seminar and 10 per cent, respectively. Organised by the European Economics & Financial Source: RBI staff estimates. Centre, London, September 4. August 12, 20232. The I-CRR was reviewed on Drivers and Management of Liquidity September 8, 2023, and discontinued in a phased III.17 Government cash balances, currency manner so that system liquidity was not subjected movements and capital flows emerged as the to sudden shocks and money markets functioned major drivers of liquidity during 2023-24 (Table in an orderly manner. Accordingly, 25 per cent III.2). At the beginning of Q1:2023-24, liquidity of the impounded I-CRR funds was released on conditions tightened in April due to the build-up September 9, another 25 per cent on September of government cash balances and the repayment 23 and the remaining 50 per cent was released on of remaining funds availed by banks under the October 7, 2023. targeted long-term repo operations (TLTROs)3 2 The existing cash reserve ratio (CRR), however, remained unchanged at 4.5 per cent. 3 Out of the total availed funds of ₹1,12,900 crore, banks repaid ₹61,113 crore during April 2023. 86  MONETARY POLICY OPERATIONS Table III.2: Liquidity – Key Drivers and Management (₹ crore) Item 2022-23 2023-24 Q1:2023-24 Q2: 2023-24 Q3: 2023-24 Q4: 2023-24 1 2 3 4 5 6 7 Drivers (i) CiC [withdrawal (-) / return (+)] -2,44,804 -1,37,011 18,103 71,253 -73,831 -1,52,536 (ii) Net Forex Purchases (+) / Sales (-) -2,17,259 3,39,528 1,60,738 -16,071 -2,348 1,97,209 (iii) GoI Cash Balances [build-up (-) / drawdown (+)] 84,028 -2,75,156 -2,37,937 -1,79,913 -6,606 1,49,301 (iv) Excess Reserves [build-up (-) / drawdown (+)] 1,17,393 -11,961 31,485 3,440 -1,217 -45,669 Management (i) Net OMO Purchases (+) / Sales (-) -31,360 -18,505 - -8,480 -10,025 - (ii) Required Reserves [including both change in 1,62,701 -1,27,716 -33,712 -1,01,508 30,605 -23,101 NDTL and CRR / I-CRR] Memo Item: Daily Net Absorption (+) / Injection (-) as at end-period 1,28,497 -52,918 1,29,194 -97,015 -1,82,679 -52,918 CiC: Currency in Circulation. GoI: Government of India. -:Nil. Note: 1. Inflow (+)/Outflow (-) to and from the banking system. 2. Data pertain to the last Friday of the respective period. Source: RBI. conducted in April 2020. Thereafter, liquidity The build-up of government cash balances due conditions eased in May in the wake of (i) the return to advance tax collections and GST payments of currency to the banking system consequent further tightened liquidity conditions and average upon the withdrawal of ₹2000 banknotes from net liquidity adjustment facility (LAF) slipped circulation; (ii) an accelerated pace of government into deficit mode in September for the first time spending before the onset of the monsoon season; since May 2019. Consequently, average net and (iii) the Reserve Bank’s market operations. LAF absorption moderated to ₹0.89 lakh crore in In June, advance tax payments and goods and Q2:2023-24 from ₹1.26 lakh crore in Q1. services tax (GST) related outflows moderated III.19 Liquidity turned into deficit with average surplus liquidity, though the seasonal return of net LAF injection of ₹0.76 lakh crore in Q3, driven currency to the banking system ameliorated some of the pressure. A 14-day variable rate repo by festival related currency outgo in October- (VRR) auction (main operation) was conducted November and build-up of government cash on May 19, 2023 followed by one fine-tuning balances due to advance tax and GST payments VRR operation in June to assuage the transient in December 2023. To alleviate the liquidity stress, tightness in liquidity conditions. the Reserve Bank conducted four fine-tuning VRR operations. III.18 In Q2, liquidity conditions remained largely comfortable during July and the first half of August III.20 Net LAF injection averaged ₹1.36 lakh as government spending augmented surplus crore in Q4, with injections narrowing considerably liquidity in the banking system. Surplus liquidity in March 2024 from January-February. Increased moderated from August 12, 2023, following government spending along with the Reserve the imposition of the I-CRR, which impounded Bank’s forex operations somewhat offset liquidity about ₹1.1 lakh crore from the banking system. drainage due to currency withdrawal. The 87  ANNUAL REPORT 2023-24 return-leg of a USD/INR Sell Buy swap auction for Chart III.2: Currency in Circulation US$ 5 billion conducted by the Reserve Bank on 60,000 March 8, 2022 also injected liquidity amounting 50,000 to ₹42,800 crore on March 11, 2024. During Q4, 40,000 the Reserve Bank injected liquidity through six 30,000 main and 19 fine-tuning VRR operations. At the 20,000 same time, fine-tuning variable rate reverse repo 10,000 0 (VRRR) auctions were conducted intermittently -10,000 to absorb surplus liquidity to ensure that money -20,000 market rates evolve in alignment with the monetary -30,000 policy stance. -40,000 -50,000 III.21 Currency in circulation is usually a 3-Apr 22-Apr 18-Jun 7-Jul 26-Jul 2-Sep 21-Sep 6-Dec 25-Dec 13-Jan 1-Feb 20-Feb 10-Mar 29-Mar 10-Oct 29-Oct 11-May 30-May 17-Nov 14-Aug predominant driver of structural liquidity in the banking system. The usual expansion in currency 2022-23 2023-24 Source: RBI. in circulation during 2023-24 was muted due to the return of currency to the banking system on account both main and fine-tuning operations (Chart III.3). of the decision to withdraw ₹2000 banknotes from Reflecting tight liquidity conditions, banks’ recourse circulation on May 19, 2023 (Chart III.2). to the marginal standing facility (MSF) increased, Liquidity Operations with average daily borrowing under the facility III.22 During 2023-24, average absorption under amounting to ₹0.50 lakh crore during 2023-24, the SDF at ₹0.90 lakh crore constituted 78 per scaling a peak of ₹2.34 lakh crore on November 22, cent of the average daily total absorption (₹1.16 2023. The simultaneous placement of substantial lakh crore) under the LAF, while the remaining 22 funds under the SDF while taking large recourse per cent was absorbed through VRRR auctions – to the MSF is somewhat paradoxical. To enable Chart III.3: Liquidity Operations a. Liquidity b. Standing Facilities 4.5 1.6 3.5 1.4 2.5 lakh crore 1.5 1.2 0.5 lakh crore 1.0 -0.5 0.8 -1.5 0.6 -2.5 -3.5 0.4 01-Apr-23 29-Apr-23 27-May-23 24-Jun-23 22-Jul-23 19-Aug-23 14-Oct-23 11-Nov-23 09-Dec-23 06-Jan-24 03-Feb-24 02-Mar-24 30-Mar-24 16-Sep-23 0.2 0.0 Jul-23 Oct-23 Apr-23 Aug-23 Sep-23 Nov-23 Dec-23 Feb-24 Jan-24 Jun-23 Mar-24 May-23 SDF MSF Source: RBI and CCIL. 88  MONETARY POLICY OPERATIONS better fund management by the banks, it was III.25 In tandem with the WACR, overnight rates decided to allow reversal of liquidity facilities under in the collateralised segment rose during the year both the SDF and the MSF even during weekends before easing since February (Table III.3). In the and holidays with effect from December 30, 2023. term money segment, yields firmed up on 3-month This provided banks with greater flexibility in their commercial paper (CP) for NBFCs, reflecting, inter operations, alleviated the tightness in liquidity alia, the regulatory measures announced by the conditions during the weekends and imparted Reserve Bank on November 16, 2023 (see Chapter greater efficiency to liquidity management. VI). Tight liquidity conditions prompted banks III.23 During 2023-24, VRRR fine-tuning to resort to issuances of certificates of deposit operations and fortnightly 14-day main operations (CDs). Medium to long-term bond yields, however, elicited average offer-cover ratios of 0.47 and eased from their March 2023 levels, taking cues 0.38, respectively. In contrast, VRR fine-tuning from domestic developments notwithstanding the and main operations had average bid-cover ratio hardening of US treasury yields. of 2.07 and 1.75, respectively, reflecting tight liquidity conditions. Table III.3: Interest Rates (Per cent) III.24 Driven by the shifting liquidity dynamics, Indicator Average for the weighted average call rate (WACR) – the Mar- Jun- Sep- Mar- operating target of monetary policy – remained 2023 2023 2023 2024 1 2 3 4 5 elevated during October 2023-January 2024. It Rates WACR 6.52 6.54 6.76 6.60 eased between mid-February 2024 and the third Tri-party Repo 6.47 6.47 6.74 6.54 week of March before hardening towards the year- Market Repo 6.55 6.46 6.78 6.61 end (Chart III.4). 3-Month T-Bill 6.88 6.75 6.96 6.92 3-Month CP 7.78 7.15 8.40 8.19 3-Month CD 7.48 6.91 7.56 7.70 Chart III.4: Policy Corridor and Weighted Average AAA Corporate 7.85 7.56 7.69 7.66 Call Rate (2023-24) Bond - 5-year 7.5 7.41 G-Sec Yield - 7.28 6.98 7.10 7.08 5-year G-Sec Yield - 7.35 7.04 7.18 7.06 10-year 7.0 Spreads CP - T-Bill 90 40 144 127 Per cent (bps) AAA 5-year - 57 58 59 59 G-Sec 5-year 6.5 Memo Items: Liquidity Net LAF 14,185 1,30,246 -14,586 -29,323 (₹ crore) 6.0 Global US 10-year 3.66 3.74 4.36 4.20 03-May-23 18-May-23 13-Mar-24 28-Mar-24 02-Jun-23 17-Jun-23 14-Nov-23 29-Nov-23 13-Jan-24 28-Jan-24 01-Aug-23 16-Aug-23 31-Aug-23 15-Sep-23 30-Sep-23 14-Dec-23 29-Dec-23 03-Apr-23 18-Apr-23 12-Feb-24 27-Feb-24 15-Oct-23 30-Oct-23 02-Jul-23 17-Jul-23 Indicators G-sec Yield (Per cent) Crude Oil Price 79 75 93 85 Weighted Average Call Rate SDF Rate (Indian Basket) Repo Rate MSF Rate [US $ per barrel] Source: RBI and CCIL. Source: CCIL, RBI and Bloomberg. 89  ANNUAL REPORT 2023-24 Monetary Policy Transmission during May 2022-March 2024. The WADTDR III.26 The transmission of the Reserve Bank’s on fresh term deposits and outstanding term policy rate changes to banks’ deposit and deposits increased by 259 bps and 185 bps, lending rates continued during 2023-24, albeit respectively, over the same period (Table III.4). at a decelerated pace. Scheduled commercial III.27 In the current tightening cycle, the interest banks’ (SCBs’) weighted average lending rate rates on savings deposits of banks - which (WALR) on fresh rupee loans and WALR on account for roughly 30 per cent of total deposits - outstanding loans increased by 5 bps and 13 have remained almost unchanged, while current bps, respectively, during 2023-24. In the case of account balances (with around 9 per cent share deposits, the weighted average domestic term in total deposits at end-March 2024) earn no deposit rate (WADTDR) on outstanding term interest. This has moderated the increase in the deposits increased in 2023-24, with an increasing banks’ overall cost of funds, mirroring in higher proportion of deposits getting renewed at higher interest rate spreads. During tightening cycles, rates. The WADTDR on fresh term deposits interest rate spreads of SCBs tend to widen increased by 14 bps during the year. Overall, initially with faster upward adjustments in lending since the beginning of the current tightening rates relative to deposit rates (Box III.2). With the cycle in May 2022, banks have revised their phased repricing of deposits, net interest margins repo-linked benchmark rates upwards by 250 bps moderate/stabilise subsequently. and their 1-year marginal cost of funds-based lending rates (MCLR) by 167 bps. Consequently, III.28 Across bank-groups, the increase in the the WALR on fresh rupee loans rose by 186 bps WALR on fresh rupee loans and WADTDR on while that on outstanding loans rose by 113 bps fresh and outstanding term deposits was higher Table III.4: Transmission from the Policy Repo Rate to Lending and Deposit Rates of SCBs (Variation in basis points) Period Repo Term Deposit Rates Lending Rates (April-March) Rate WADTDR – WADTDR – 1-year EBLR WALR – WALR – Fresh Outstanding MCLR Fresh Outstanding Deposits Deposits (Median) Rupee Rupee Loans Loans 1 2 3 4 5 6 7 8 2021-22 0 27 -25 -5 0 -29 -36 2022-23 250 236 113 150 250 169 98 2023-24 0 14 72 30 0 5 13 Memo Items: February 2019 to March 2022 (Easing Cycle) -250 -259 -188 -155 - -232 -150 May 2022 to March 2024 (Tightening Cycle) 250 259 185 167 250 186 113 -: Nil. WADTDR: Weighted Average Domestic Term Deposit Rate. WALR: Weighted Average Lending Rate. MCLR: Marginal Cost of Funds-based Lending Rate. EBLR: External Benchmark-based Lending Rate. Note: Data on EBLR pertain to domestic banks. Source: RBI. 90  MONETARY POLICY OPERATIONS Box III.2 Interest Rate Spread and Monetary Policy Transmission The interest rate spread (IRS) - the difference between benchmark regression, which includes only monetary policy the weighted average lending rate on fresh loans and the rate, while Model II includes bank-specific characteristics weighted average rate on total deposits of banks - impacts along with monetary policy rate (Table 1). monetary transmission. Drawing from Arellano-Bover (1995) and Blundell & Bond (1998), a dynamic panel framework Table 1: Interest Rate Spread of Banks in India using the system generalised method of moments Dependent Variable: IRS Model I Model II (Roodman, 2009) on quarterly data of 27 SCBs (12 public Explanatory Variable and 15 private sector banks) for the period Q4:2018-19 1 2 3 to Q1:2023-24 with bank-specific control variables, viz., size (log of total assets of banks), gross non-performing IRS (-1) 0.49*** 0.51*** WACR 0.08*** asset (GNPA) ratio, capital to risk-weighted assets ratio WACR (-1) 0.09*** 0.15*** (CRAR) and credit-deposit (CD) ratio indicates that a 100 Size -0.16*** bps increase in the WACR increases banks’ IRS in the GNPA (-1) -0.02** short-run by 15-17 bps, as the pace of upward adjustment CRAR (-2) 0.04*** in term deposit rates lags that in lending rates. The model CDRATIO (-2) 0.01 takes the following form: Constant 2.34*** 2.27*** , =µ + =1 ,( ) + =0 + Diagnostics + … (I) AR (1) -2.86** -2.85** =0 ,( ) , AR (2) 1.03 1.26 where, Xb,t represents the bank-specific variables for bank Sargan (p) 0.31 0.15 ‘b’ at time ‘t’. wacrt is the weighted average call rate at time Number of Banks 27 27 ‘t’, a proxy for monetary policy rate. ɛb,t denotes stochastic Observations 486 486 disturbance term that contains unobserved bank-specific *** and ** represent significance levels at 1 per cent and 5 effect (time invariant) and idiosyncratic disturbances (varies per cent, respectively. across time but not across banks). Model I estimates the Source: RBI staff estimates. References: 1. Arellano, M., and Bover, O. (1995), ‘Another Look at the Instrumental Variable Estimation of Error-Components Models’, Journal of Econometrics, 68(1), 29-51. 2. Blundell, R., & Bond, S. (1998), ‘Initial Conditions and Moment Restrictions in Dynamic Panel Data Models’, Journal of Econometrics, 87(1), 115-143. 3. Roodman, D. (2009), ‘How to Do xtabond2: An Introduction to Difference and System GMM in Stata’, The Stata Journal, 9(1), 86-136. in case of public sector banks (PSBs) relative to External Benchmark-based Loan Rates private banks (PVBs) in the current tightening III.29 The external benchmark regime cycle (Chart III.5). The transmission was the introduced in October 2019 for loan pricing in highest in the case of foreign banks, facilitated select sectors has strengthened the pace of by their low cost and lower duration deposits, monetary transmission to the lending rates. The which enables them to make quicker adjustments proportion of outstanding floating rate loans linked in response to policy rate changes. to external benchmarks increased from 44 per 91  ANNUAL REPORT 2023-24 Chart III.5: Transmission to Lending and Deposit Rates across Bank-Groups a. February 2019 - March 2022 b. May 2022 - March 2024 0 350 317 300 295 -50 300 265 Variation (Basis points) Variation (Basis points) -100 250 222 -120 -120 -150 191 190 185 -145 -145 176 200 170 169 -163 163 155 -200 -197 -200 -202 150 114 -250 104 -276 -275 -300 100 -350 -334 50 -351 -400 0 WADTDR WALR (Fresh WALR (Outstanding 1-Year Median WADTDR WADTDR WALR WALR 1-Year Median (Outstanding Rupee Loans) Rupee Loans) MCLR (Fresh Deposit) (Outstanding (Fresh Rupee (Outstanding MCLR Deposits) Deposit) Loans) Loans) Public Sector Banks Private Banks Foreign Banks Public Sector Banks Private Banks Foreign Banks Source: RBI. cent in March 2022 to 56.2 per cent in December and other personal loans were lower than those of 2023. The loans linked to external benchmarks PVBs. In the case of MSME loans, however, the thus account for the largest share in total floating spread charged by PSBs was higher (Table III.6). rate loans. Concomitantly, the share of the MCLR- The spreads have generally declined in 2023-24, linked loans fell from 48.6 per cent to 39.4 per cent moderating the extent of pass-through to lending over the same period (Table III.5). rates. III.30 In the case of loans linked to the policy Sectoral Lending Rates repo rate, the spread in respect of fresh rupee III.31 The WALRs on fresh rupee loans rose loans, i.e., WALR over the repo rate, was the marginally for agricultural loans, large industry, highest for education loans, followed by micro, MSMEs, infrastructure and education, and small and medium enterprise (MSME) loans. declined marginally for sectors such as trade, Among the domestic bank groups, the spreads housing, vehicle, and rupee export credit during charged by PSBs for housing, vehicle, education 2023-24 (Table III.7). Table III.5: Outstanding Floating Rate Rupee Loans of SCBs across Interest Rate Table III.6: Loans Linked to External Benchmark – Spread of WALR (Fresh Rupee Loans) over Benchmarks Repo Rate (March 2024) (Per cent to total) (Percentage points) Month Base MCLR EBLR Others Total Bank Group Personal Loans MSME Rate Loans Housing Vehicle Education Other 1 2 3 4 5 6 Personal March 2021 6.4 62.3 29.5 1.8 100.0 Loans March 2022 4.9 48.6 44.0 2.5 100.0 1 2 3 4 5 6 March 2023 3.1 45.4 49.6 1.9 100.0 Public Sector Banks 2.06 2.56 3.62 3.04 3.34 December 2023 2.4 39.4 56.2 2.0 100.0 Private Sector Banks 2.23 3.00 4.39 3.33 3.24 Domestic Banks 2.18 2.64 3.98 3.08 3.27 Note: Data pertain to 73 scheduled commercial banks. Source: RBI. Source: RBI. 92  MONETARY POLICY OPERATIONS Table III.7: Sector-wise WALR of SCBs (Excluding RRBs) - Fresh Rupee Loans (Per cent) End-Month Agriculture Industry MSMEs Infrastructure Trade Professional Personal Loans