Monetary Policy Report – October 2023

Published under Section 45ZM of the Reserve Bank of India Act, 1934 Monetary Policy Report OCTOBER 2023 Reserve Bank of India MumbaiContents Chapter I: Macroeconomic Outlook 1 I.1: Key Developments since the April 2023 MPR 1 I.2: The Outlook for Inflation 4 I.3: The Outlook for Growth 8 I.4: Balance of Risks 10 I.5: Conclusion 14 Box I.1: Monetary Policy Reports as a Communication Tool: Textual Analysis 7 Box I.2: Inflation Co-movements and Idiosyncrasies: A Cross-Country Analysis 11 Chapter II: Prices and Costs 15 II.1: Consumer Prices 15 II.2: Drivers of Inflation 18 II.3: Costs 31 II.4: Conclusion 34 Box: II.1: Vegetable Retail Margins: Some Stylised Evidence 25 Chapter III: Demand and Output 35 III.1: Aggregate Demand 35 III.2: Aggregate Supply 45 III.3: Conclusion 54 Box III.1: Asymmetric Impact of Energy Prices on Economic Activity 46 Chapter IV: Financial Markets and Liquidity Conditions 55 IV.1: Domestic Financial Markets 55 IV.2: Monetary Policy Transmission 70 IV.3: Liquidity Conditions and the Operating Procedure of Monetary Policy 74 IV.4: Conclusion 78 Box IV.1: Bank Credit and Growth Dynamics 68 Chapter V: External Environment 79 V.1: Global Economic Conditions 79 V.2: Commodity Prices and Inflation 82 V.3: Monetary Policy Stance 87 V.4: Global Financial Markets 89 V.5: Conclusion 91 Box V.1: Global Core and Headline Inflation Dynamics 85 iABBREVIATIONS AEs - Advance Estimates CII - Confederation of Indian Industry AEs - Advanced Economies CLI - Composite Leading Indicator AIDC - Agriculture Infrastructure and CMIE - Centre for Monitoring Indian Development Cess Economy APP - Asset Purchase Programme COVID-19 - Coronavirus Disease 2019 AR - Autoregressive CP - Commercial Paper ASEAN - Association of Southeast Asian CPB - Central Planning Bureau Nations CPI - Consumer Price Index ATF - Aviation Turbine Fuel CPI-AL - Consumer Price Index for ATM - At the money Agricultural Labourers BDI - Baltic Dry Index CPI-IW - Consumer Price Index for Industrial BE - Budget Estimates Workers BIES - Business Inflation Expectations CPI-RL - Consumer Price Index for Rural Survey Labourers BIS - Bank for International Settlements CRR - Cash Reserve Ratio BoE - Bank of England CSI - Current Situation Index BoJ - Bank of Japan CU - Capacity Utilisation BoR - Bank of Russia DCA - Department of Consumer Affairs bps - Basis points DGCA - Directorate General of Civil Aviation BRICS - Brazil, Russia, India, China and South DGCI&S - Directorate General of Commercial Africa Intelligence and Statistics BSE - Bombay Stock Exchange DI - Diffusion Index CACP - Commission for Agricultural Costs DII - Domestic Institutional Investor and Prices EBIT - Earnings Before Interest and Taxes CAG - Comptroller and Auditor General EBLR - External Benchmark Lending Rate CCIL - Clearing Corporation of India Limited ECB - European Central Bank CDs - Certificates of Deposit ECB - External Commercial Borrowing CDS - Credit Default Swap ECI - Eight Core Industries CI - Confidence Interval EIA - Energy Information Administration CiC - Currency in Circulation EMEs - Emerging Market Economies iiiiiiMonetary Policy Report October 2023 EPFO - Employees’ Provident Fund G-Secs - Government Securities Organisation GST - Goods and Services Tax FAO - Food and Agriculture Organization GVA - Gross Value Added FBIL - Financial Benchmarks India Pvt. Ltd H1 - First Half of the Financial Year (April- FCNR - Foreign Currency Non-Resident September) FDI - Foreign Direct Investment H2 - Second Half of the Financial Year (October-March) Fed - Federal Reserve HFI - High Frequency Indicator FEI - Future Expectations Index HSD - High-Speed Diesel FI - Financial Institution ICICI - Industrial Credit and Investment FICCI - Federation of Indian Chambers of Corporation of India (Bank) Commerce and Industry ICR - Interest Coverage Ratio FIMMDA - Fixed Income Money Market and Derivatives Association of India I-CRR - Incremental Cash Reserve Ratio FK - Flesch–Kincaid Readability Index IIF - Institute of International Finance FL - Family Labour IIP - Index of Industrial Production FOMC - Federal Open Market Committee IMD - India Meteorological Department FPI - Foreign Portfolio Investment/Investor IMF - International Monetary Fund FRBSF - Federal Reserve Bank of San INR - Indian Rupee Francisco IOCL - Indian Oil Corporation Limited FRE - First Revised Estimate IOD - Indian Ocean Dipole F-TRAC - FIMMDA Trade Reporting and IRDAI - Insurance Regulatory and Confirmation System Development Authority FTSE - Financial Times Stock Exchange IRFCL - International Reserves and Foreign GDFM - Generalised Dynamic Factor Model Currency Liquidity GDP - Gross Domestic Product IT - Information Technology GF - Gunning-Fog Readability Index JSE - Johannesburg Stock Exchange GFCE - Government Final Consumption LAF - Liquidity Adjustment Facility Expenditure LPA - Long Period Average GFCF - Gross Fixed Capital Formation LPG - Liquefied Petroleum Gas GMM - Generalized Method of Moments LPR - Loan Prime Rate GNDI - Gross National Disposable Income MCLR - Marginal Cost of Funds Based GoI - Government of India Lending Rate GSDP - Gross State Domestic Product MFs - Mutual Funds iivvAbbreviations MMRP - Modified Mixed Reference Period PADO - Public Administration, Defence and Other Services MOEX - Moscow Exchange PBoC - People’s Bank of China M-o-M - Month-on-Month PCE - Personal Consumption Expenditure MOSPI - Ministry of Statistics and Programme Implementation PE - Provisional Estimates MPC - Monetary Policy Committee PEPP - Pandemic Emergency Purchase Programme MPR - Monetary Policy Report PFCE - Private Final Consumption MSCI - Morgan Stanley Capital International Expenditure MSF - Marginal Standing Facility PMG - Pooled Mean Group MSME - Micro, Small and Medium PMI - Purchasing Managers’ Index Enterprises POL - Petroleum, Oil and Lubricants MSP - Minimum Support Price POSOCO - Power System Operation Corporation NBFCs - Non-Banking Financial Companies Limited NCAER - National Council of Applied PPAC - Petroleum Planning and Analysis Cell Economic Research PRN - Production Weighted Rainfall NDS - Negotiated Dealing System PSB - Public Sector Bank NDTL - Net Demand and Time Liabilities PSU - Public Sector Undertaking NEER - Nominal Effective Exchange Rate PVB - Private Sector Bank NIM - Net Interest Margin Q1 - First Quarter NPA - Non-Performing Asset Q2 - Second Quarter NSC - National Savings Certificate Q3 - Third Quarter NSDL - National Securities Depository Q4 - Fourth Quarter Limited q-o-q - Quarter-on-Quarter NSO - National Statistical Office QPM - Quarterly Projection Model NSSO - National Sample Survey Office RBI - Reserve Bank of India OECD - Organisation for Economic Co- operation and Development RE - Revised Estimates OMO - Open Market Operation RECO - Revenue Expenditure to Capital Outlay OPEC - Organization of the Petroleum Exporting Countries REER - Real Effective Exchange Rate OTC - Over-the-Counter RHS - Right Hand Side PA - Provisional Accounts RM - Reserve money vvMonetary Policy Report October 2023 S&P - Standard and Poor VAR - Vector Autoregression SAAR/saar - Seasonally Adjusted Annualised Rate VECM - Vector Error Correction Model SCB - Scheduled Commercial Bank VIX - Volatility Index of Chicago Board Options Exchange SDF - Standing Deposit Facility VRR - Variable Rate Repo SEBI - Securities and Exchange Board of India VRRR - Variable Rate Reverse Repo SGS - State Government Securities WAC - Weighted Average Coupon SIAM - Society of Indian Automobile WACR - Weighted Average Call Money Rate Manufacturers WADR - Weighted Average Discount Rate SLR - Statutory Liquidity Ratio WADTDR - Weighted Average Domestic Term SSE - Shanghai Stock Exchange Deposit Rate SSI - Small Savings Instruments WALR - Weighted Average Lending Rate STU - Stocks-to-Use WAM - Weighted Average Maturity SVAR - Structural Vector Auto Regression WAR - Weighted Average Rate TBs - Treasury Bills WEO - World Economic Outlook TREPS - Tri Party Repo Dealing System WHO - World Health Organization TRQ - Tariff Rate Quota WMA - Ways and Means Advances UK - United Kingdom US - United States WPI - Wholesale Price Index US$ - US Dollar WTO - World Trade Organization USA - United States of America YCC - Yield Curve Control UT - Union Territory y-o-y - Year-on-Year vviiI. Macroeconomic Outlook The outlook for domestic economic activity remains resilient in spite of large supply shocks that have pushed up the trajectory of headline inflation. Energy and food price volatility, geopolitical hostilities, tightening external financial conditions and climate shocks are the key risks to the outlook. Monetary policy remains focused on aligning inflation with the target to pave the path for sustained growth in the medium-term. I.1 Key Developments since the April 2023 MPR in response to extended output cuts by key producing countries. Food prices are volatile on supply concerns Global economic activity and trade are slowing, arising from the breakdown of the Black Sea deal on although unevenly across geographies and sectors. Ukrainian grain movements and the El Niño weather Tightening financial conditions in response to phenomenon. monetary actions to address still elevated inflation, persisting geopolitical tensions and growing Turning to the domestic economy, activity was geoeconomic fragmentation render the outlook supported in H1:2023-24 by private consumption fragile. Manufacturing activity is contracting across and fixed investment, although adverse external many countries, while services are relatively resilient. conditions are being reflected in a prolonged Headline inflation has been gradually easing across contraction in net exports. Real gross domestic the world, however, in most countries, it remains product (GDP) rose by 7.8 per cent (year-on-year, elevated in relation to targets. Core inflation is y-o-y) in Q1:2023-24 (April-June) and high frequency moderating but at a tardy pace and services inflation indicators for Q2 suggest that the momentum in is sticky. These concerns are reflected in 'higher for activity is being maintained. On the supply side, real longer' monetary policy settings. In some countries, gross value added (GVA) is being buoyed by services however, the monetary policy tightening cycle is sector growth. complete or nearing it or even in accommodation in response to weakening economic activity. Headline CPI inflation had moderated from an average of 6.7 per cent in 2022-23 to 4.3 per cent in May 2023 in Market expectations relating to the global economic response to monetary policy actions and supply side outlook are fluctuating widely and sensitive to every measures. Reversing these gains under the impact of incoming information, imparting high volatility. In sporadic food supply shocks, inflation jumped to 7.4 September, US sovereign bond yields touched their per cent in July and 6.8 per cent in August. On the highest levels since the global financial crisis, and the other hand, core inflation (i.e., CPI excluding food yield curve has seen its longest period of inversion and fuel) has been gradually ebbing down to sub-5 per since 1980. Credit growth in major economies is cent levels. With the cumulative rate hike of 250 basis decelerating in response to monetary tightening. After strong gains in the first half of 2023, global points (bps) undertaken during May 2022-February equity markets retreated in Q3 (July-September). 2023 working its way into the economy, the monetary The US dollar depreciated to a 15-month low in mid- policy committee (MPC) kept the policy repo rate July but has recovered subsequently on better-than- unchanged at 6.50 per cent through H1, and it remains expected US economic data. Crude oil prices firmed firmly committed to aligning inflation with the target up sharply to around US$ 95 per barrel in September going forward. 1Monetary Policy Report October 2023 Monetary Policy Committee: April 2023 - September inflation trajectory from a spike in vegetable prices. 2023 Factoring in the skewed south-west monsoon outturn, the growing likelihood of an El Niño event and the When the MPC met in April 2023, the global economy worsening global food prices outlook, the inflation was going through a period of heightened volatility in projection for 2023-24 was revised upwards by 30 bps the wake of banking sector turmoil in some advanced to 5.4 per cent while the April 2023 projection for economies (AEs). Domestic CPI headline inflation was real GDP was kept unchanged. Taking into account ruling above the upper threshold of the tolerance band the cumulative policy repo rate increase undertaken in January and February, but was expected to soften thus far, the MPC unanimously decided to keep the with a record rabi foodgrains production, easing input policy repo rate unchanged at 6.50 per cent with cost conditions and normalisation of supply chain preparedness to undertake policy responses. With a 5 pressures. CPI inflation was projected at 5.2 per cent to 1 vote, the MPC reiterated its stance of withdrawal for 2023-24, 10 bps lower than the February projection. of accommodation. Domestic economic activity was seen to be holding up well, and the real GDP growth projection for 2023-24 The MPC’s voting pattern reflects the diversity in was raised to 6.5 per cent from 6.4 per cent in the individual members’ assessments, expectations and February meeting. Considering these factors and that policy preferences, a characteristic also reflected in previous rate hikes were still working through the voting patterns of other central banks (Table I.1). system, the MPC unanimously decided to keep the Macroeconomic Outlook policy repo rate unchanged at 6.50 per cent, but with a Chapters II and III analyse macroeconomic readiness to act, should the situation so warrant. The developments relating to inflation and economic MPC decided by a majority of 5-1 to remain focused on activity during H1:2023-24 (April–September withdrawal of accommodation to ensure that inflation progressively aligns with the target, while supporting Table I.1: Monetary Policy Committees and Policy growth. Rate Voting Patterns At the time of the June 2023 meeting, CPI headline Country Policy Meetings: April 2023 – September 2023 inflation had fallen to 4.7 per cent (April 2023 print) Total Meetings Meetings Variation from an average of 6.2 per cent during the previous meetings with full without in policy consensus full rate (basis quarter. The MPC noted that the moderation in consensus points) CPI headline inflation reflected the combined and Brazil 4 3 1 -100 continuing impact of monetary policy tightening, Chile 5 4 1 -175 supply augmenting measures and the fuller impact of Colombia 4 2 2 25 the previous rate hikes which should keep inflationary Czech Republic 4 2 2 0 pressures contained in the coming months. Against Hungary 6 6 0 0 this backdrop, the MPC unanimously voted again to India 3 3 0 0 keep the policy repo rate unchanged at 6.50 per cent Japan 4 4 0 0 South Africa 3 1 2 50 and with a 5-1 vote to continue with its stance of Sweden 3 2 1 100 withdrawal of accommodation. Thailand 3 3 0 75 In the run up to the August 2023 meeting, headline UK 4 0 4 100 CPI inflation picked up to 4.8 per cent in June, with US 4 4 0 50 sizeable upside pressures on the near-term headline Sources: Central bank websites. 2Chapter I Macroeconomic Outlook Chart I.1: Crude Oil Prices a: Brent Prices b: World Oil Production, c. Global Crude and Product Prices Consumption and Change in Stock 115 105 95 arrel 85 erb 75 p $ 65 S U 55 45 35 25 111222233334444 222222222222222 Apr- Jul- Oct- Jan- Apr- Jul- Oct- Jan- Apr- Jul- Oct- Jan- Apr- Jul- Oct- Spotprice Futures-March31,2023 Futures-September29,2023 Sources: Bloomberg; US Energy Information Administration (EIA); and Petroleum Planning & Analysis Cell. 2023). Turning to the baseline assumptions, first, Table I.2: Baseline Assumptions for Projections international crude prices have exhibited sizeable Indicator MPR April 2023 MPR October 2023 two-way movements in H1, easing in April amidst Crude Oil (Indian basket) US$ 85 per barrel US$ 85 per barrel a banking crisis in the US and underwhelming during 2023-24 during H2:2023-24 Chinese recovery, but they moved higher beginning Exchange rate ` 82/US$ during ` 82.5/US$ during 2023-24 H2:2023-24 July, with Brent crude crossing US dollar (US$) 90 per Monsoon Normal for 2023-24 6 per cent below long barrel in September due to production cuts referred period average for to earlier, with some correction in early October. 2023-24 Geopolitical tensions impart significant uncertainty Global growth 2.9 per cent in 2023 3.0 per cent in 2023 3.1 per cent in 2024 3.0 per cent in 2024 to the outlook (Chart I.1.a and Chart I.1.b). The ‘crack’ Fiscal deficit To remain within BE To remain within BE spread – the wedge between global petroleum product (per cent of GDP) 2023-24 2023-24 Centre: 5.9 Centre: 5.9 prices and crude prices – is elevated in view of Combined: 8.5 Combined: 8.5 demand-supply refinery mismatches (Chart I.1.c). Domestic macroeconomic/ No major change No major change Taking into account these developments, the structural policies during the forecast period baseline assumption for crude price (Indian basket) Notes: 1. The Indian basket of crude oil represents a derived numeraire is retained at US$ 85 per barrel (Table I.2). comprising sour grade (Oman and Dubai average) and sweet grade (Brent) crude oil. Second, the nominal exchange rate of the Indian 2. The exchange rate path assumed here is for the purpose of rupee or INR has moved in both directions around the generating the baseline projections and does not indicate any ‘view’ on the level of the exchange rate. The Reserve Bank is April baseline, varying in a range of INR 81.7-83.3 per guided by the objective of containing excess volatility in the foreign exchange market and not by any specific level of and/or US$ in H1. Taking into consideration the uncertainty band around the exchange rate. around US dollar movements, the ebbs and flows of 3. BE: Budget estimates. 4. Combined fiscal deficit refers to that of the Centre and States global capital, and international crude oil prices, the taken together. baseline assumption for the exchange rate is revised Sources: RBI estimates; Budget documents; and IMF. to INR 82.5 per US dollar. 3Monetary Policy Report October 2023 Chart I.2: Global GDP Growth and Inflation Chart I.3: Inflation Expectations of Households Source: IMF. Source: Inflation Expectations Survey of Households, RBI. Third, multiple headwinds – tighter monetary and I.2 The Outlook for Inflation fiscal policies, reduced pent-up demand, financial Looking ahead, the sharp spike in food prices, stability risks, continued geopolitical challenges especially of vegetables, has started correcting and geoeconomic fragmentation – weigh heavily (Chapter II). The three months and one year ahead on global growth prospects. The global purchasing median inflation expectations of urban households managers’ index (PMI) for manufacturing has fell by 90 and 40 bps, respectively, to 9.1 per cent remained in contraction mode since September and 9.9 per cent in the September 2023 round of the 2022, while the services PMI is moderating since Reserve Bank’s survey1 vis-à-vis the previous round. May 2023, albeit still in expansion mode. In its July Notably, inflation expectations fell to a single digit 2023 update of the World Economic Outlook (WEO), for the first time since the COVID-19 pandemic. The the International Monetary Fund (IMF) revised its proportion of respondents expecting the general global growth forecast for 2023 marginally upwards price level to increase by more than the current rate to 3.0 per cent from its April projection of 2.8 per declined considerably for both the horizons vis-à-vis cent (Chart I.2). Yet, global GDP growth for 2023 and the previous round (Chart I.3). 2024 (3.0 per cent each) will trail its 2022 level (3.5 Manufacturing firms polled in the July-September per cent) as well as its historical (2000-19) average of 2023 round of the Reserve Bank’s industrial outlook 3.8 per cent. Global trade growth (goods and services survey expect increased pressures from the cost of combined) is projected by the IMF to decelerate from raw materials but marginal decline in selling price 5.2 per cent in 2022 to 2.0 per cent in 2023. growth in Q3:2023-24 (Chart I.4a).2 Services and 1 The Reserve Bank’s inflation expectations survey of households is being conducted in 19 cities since March 2021 (18 cities in the previous rounds) and the results of the September 2023 round are based on responses from 6066 households. 2 The results of the July-September 2023 round of the industrial outlook survey are based on responses from 1223 companies. 4Chapter I Macroeconomic Outlook Chart I.4: Expectations for Cost of Raw Materials/Inputs and Selling Prices a. Manufacturing Firms b. Services Firms c. Infrastructure Firms Note: Net response is the difference between the share of respondents reporting optimism and those reporting pessimism. The range is -100 to 100. A positive/ negative value of net response is considered as optimistic/pessimistic from the view point of respondent firms. Therefore, higher positive values of selling prices indicate increase in output prices while lower values for the cost of raw materials/cost of inputs indicate higher input price pressures and vice versa. Sources: Industrial Outlook Survey; and Services and Infrastructure Outlook Survey, RBI. infrastructure firms expect lower growth in input year ahead expectations remained unchanged at 4.5 cost and selling prices in Q3:2023-24 (Charts I.4b per cent (Chart I.5b). and I.4c).3 In the PMI surveys for September 2023, Looking ahead, the outlook for inflation will be manufacturing firms reported a decline in input cost conditioned heavily by food inflation dynamics. inflation but an increase in output price inflation; The south-west monsoon rainfall has been uneven, services firms reported moderation in both input with August recording a 36 per cent deficiency in and output price pressures. rainfall. Water reservoir levels have dipped and El Professional forecasters surveyed by the Reserve Niño conditions are taking hold although the Indian Bank in September 2023 expect headline CPI inflation Ocean Dipole (IOD) has turned positive which could to moderate from 6.6 per cent in Q2:2023-24 to 5.5 limit El Niño effects. Kharif sowing has exceeded last per cent in Q3, 5.1 per cent in Q4 and 5.2-4.0 per year’s levels but with shortfalls in area under pulses cent in H1:2024-25 (Chart I.5a and Table I.3).4 Core and oilseeds. Global supply chains are improving from inflation (i.e., CPI excluding food and beverages, their pandemic disruptions. Geopolitical hostilities pan, tobacco and intoxicants, and fuel and light) pose upside risks to global commodity prices across expectation was seen at 4.9 per cent in Q2:2023-24, the board – food, crude oil and metals. Taking into 4.7 per cent in Q3, 4.6 per cent in Q4 and 4.6-4.7 per account the initial conditions, signals from forward- cent in H1:2024-25. Long-run inflation expectations looking surveys and estimates from time-series and of professional forecasters measured by their 5-year structural models5, CPI inflation is projected to average ahead expectations softened to 4.9 per cent while 10- 5.4 per cent in 2023-24 – 6.4 per cent in Q2, 5.6 per 3 Based on 581 services companies and 104 infrastructure firms polled in the July-September 2023 round of the services and infrastructure outlook survey. 4 41 panellists participated in the September 2023 round of the Reserve Bank’s survey of professional forecasters. 5 Joice John, Deepak Kumar, Asish Thomas George, Pratik Mitra, Muneesh Kapur and Michael Debabrata Patra (2023), “A Recalibrated Quarterly Projection Model (QPM 2.0) for India”, Reserve Bank of India Bulletin, February, Volume LXXVII(2), pp.59-77. 5Monetary Policy Report October 2023 Chart I.5: Inflation Expectations of Professional Forecasters Chart I.5 a: CPI Inflation Expectations : Short-run* Chart I.5 b: CPI Inflation Expectations: Long-run 8 7 nt) ce6 er P ( e at5 r n o ati nfl4 I 3 4555666777888999000111222333 1111111111111111222222222222 p-n-y-p-n-y-p-n-y-p-n-y-p-n-y-p-n-y-p-n-y-p-n-y-p-n-y-p- Se JaMa Se JaMa Se JaMa Se JaMa Se JaMa Se JaMa Se JaMa Se JaMa Se JaMa Se SurveyRound Fiveyearsahead Tenyearsahead *: Four quarters ahead expectations in September 2023. Sources: Survey of Professional Forecasters, RBI; and NSO. cent in Q3 and 5.2 per cent in Q4, with risks evenly Table I.3: Projections - Reserve Bank and balanced (Chart I.6). The 50 per cent and the 70 per Professional Forecasters (Per cent) cent confidence intervals for headline inflation in 2023-24 2024-25 Q4:2023-24 are 4.1–6.3 per cent and 3.5–6.9 per cent, Reserve Bank’s Baseline Projections respectively. For 2024-25, assuming a normal monsoon, Inflation, Q4 (y-o-y) 5.2 4.3 and no further exogenous or policy shocks, structural Real GDP growth 6.5 6.5 Median Projections of Professional Chart I.6: Projection of CPI Inflation (y-o-y) Forecasters Inflation, Q4 (y-o-y) 5.1 - Real GDP growth 6.2 6.3 Gross domestic saving (per cent of GNDI) 29.7 29.6 Gross capital formation (per cent of GDP) 31.1 31.6 Credit growth of scheduled commercial banks 13.5 12.9 Combined gross fiscal deficit (per cent of GDP) 8.7 8.3 Central government gross fiscal deficit (per 5.9 5.4 cent of GDP) Repo rate (end-period) 6.50 - Yield on 91-days treasury bills (end-period) 6.8 6.2 Yield on 10-year central government 7.0 6.8 securities (end-period) Overall balance of payments (US$ billion) 22.6 11.3 Note: The fan chart depicts uncertainty around the baseline projection Merchandise exports growth -5.9 6.0 path. The baseline projections are conditioned upon the assumptions set out in Table I.2. The thick red shaded area represents 50 per cent confidence interval, Merchandise imports growth -4.5 6.0 implying that there is 50 per cent probability that the actual outcome will be Current account balance (per cent of GDP) -1.5 -1.6 within the range given by the thick red shaded area. Likewise, for 70 per cent and 90 per cent confidence intervals, there is 70 per cent and 90 per cent probability, respectively, that the actual outcomes will be in the range represented by the Note: GNDI: Gross National Disposable Income. respective shaded areas. Source: RBI staff estimates; and Survey of Professional Forecasters Source: RBI staff estimates. (September 2023). 6Chapter I Macroeconomic Outlook model estimates indicate that inflation will average 4.5 emanate from an early resolution of geopolitical per cent, in a range of 3.8-5.2 per cent. In Q4:2024-25, tensions, a steep correction in global crude and commodity prices in the event of a sharp slowdown CPI inflation is projected at 4.3 per cent, with the 50 per in the global growth, and further improvement in cent and the 70 per cent confidence intervals at 3.0–5.6 supply conditions. per cent and 2.3–6.3 per cent, respectively. Monetary policy communication has emerged as The baseline forecasts are subject to several upside an important tool for managing and anchoring and downside risks. The upside risks emanate from expectations and strengthening monetary more persistent food price increases due to weather- transmission in an environment of heightened related disturbances, which could then feed into uncertainty. A textual analysis of the Reserve inflation expectations; further hardening of global Bank’s MPRs shows that their tone has been in commodity prices amidst an escalation of geopolitical consonance with the evolving price and output tensions; and a larger pass-through of input cost developments, which strengthens the monetary pressures to output prices. The downside risks could policy communication channel (Box I.1). Box I.1: Monetary Policy Reports as a Communication Tool: Textual Analysis Central banks communicate through a variety of Communication can be more effective if it is easily channels – monetary policy statements; speeches; understood by the general public. For this, the readability press conferences; minutes; testimonies; and monetary of the MPRs is checked using Flesch–Kincaid (FK) Grade policy (or inflation) reports. A growing literature is Level and Gunning-Fog (FOG) indices (Ferrara and Angino, undertaking a quantitative textual analysis of these 2022). The scores provided by these indices can be documents, especially monetary policy reports (MPRs), to interpreted as the number of years of education required assess the communication tone (Cherry and Tong, 2023). A to understand a text. The higher the score, the greater the textual analysis of the Reserve Bank’s 15 MPRs (Chapters complexity of the language used. 1-3) since April 2016 is undertaken by using a pre- determined list of positive and negative words (Loughran sentences and McDonald, 2011). The quantitative estimate of MPR’s 8 tone and subjectivity is obtained by estimating two sentences parameters - Polarity Ratio6 and Subjectivity Ratio7. The tone of the MPRs, as seen from the polarity score, is within the neutral range (-0.5 to +0.5) and has moved in line with the evolving price and output developments (Chart I.1.1). The MPR has turned more objective over time, as indicated by the downward sloping subjectivity where and are the number of words index. According to the readability indices, the MPRs matched with the pre-determined list in each report and require at least a high school education for understanding9 is the total number of words used. them, notwithstanding some recent improvement. (Contd.) 6 The polarity score is a ratio between -1 and 1. A score in the range of -1 to -0.5 typically indicates negative sentiment, between -0.5 and 0.5 neutral sentiment, and 0.5 to 1 positive sentiment. 7 The subjectivity score captures the number of words that carry sentiment as a proportion of total number of words. 8 Complex words are words with three or more syllables, and that are not proper nouns. 9 This is in line with literature whereby central bank monetary policy press documents are generally observed to have FK and FOG scores in the range of 12-18 years and 17-23 years, respectively. 7Monetary Policy Report October 2023 Chart I.1.1: Sentiment and Readability Tests a: Polarity and Subjectivity b: Polarity and Inflation Deviation from Target c: Polarity and Growth d: Readability Note: Shaded area in Chart a indicates neutral sentiment for polarity ratio. Source: RBI staff estimates. References: Cherry R., and Tong E. (2023), “Words of RBNZ: Textual Analysis of Monetary Policy Statement”, Analytical Notes AN2023/4, Reserve Bank of New Zealand. Ferrara M. F., and Angino S. (2022), “Does Clarity Make Central Banks More Engaging? Lessons from ECB Communications”, European Journal of Political Economy, Vol. 74,102146. Loughran T., and McDonald B. (2011), “When Is a Liability Not a Liability? Textual Analysis Dictionaries and 10-Ks”, The Journal of Finance, Vol. LXVI (1), pp. 35-65. Misra S., and Aastha (2023), “How does the Monetary Policy Report (MPR) Fare as a Communication Tool? Evidence from Textual Analysis”, mimeo. I.3 The Outlook for Growth global financial conditions, however, weigh heavily on the outlook. Domestic economic activity is being supported by robust agricultural performance, sustained buoyancy Turning to the key messages from forward-looking in contact-intensive services, the boost to investment surveys, consumer confidence (the current situation from the government’s thrust on capital expenditure, index) has improved in the September 2023 survey above trend capacity utilisation in manufacturing, round vis-à-vis the previous round on account of double digit credit growth, and healthier corporate better perceptions on the general economic and and bank balance sheets. Slowing global growth, employment situation. Consumers’ optimism for the drag from exports, geopolitical risks and volatile the year ahead, measured by the future expectations 8 oitaR erocS oitaR erocS oitaRChapter I Macroeconomic Outlook optimistic about demand conditions in Q3:2023-24 Chart I.7: Consumer Confidence (Chart I.8a). While the optimism of services sector companies waned in Q3 vis-à-vis the previous round, infrastructure sector companies remain upbeat in terms of the overall business situation (Charts I.8b and I.8c). Recent surveys by other agencies signal a mixed picture on business expectations relative to the previous round (Table I.4). Manufacturing and services firms in the PMI surveys for September 2023 exhibited optimism for the year ahead. The professional forecasters polled in the September 2023 round of the Reserve Bank’s survey expect real GDP growth at 6.3 per cent in Q2:2023-24, 5.8 per Source: Consumer Confidence Survey, RBI. cent in Q3, 5.4 per cent in Q4 and 6.0-6.4 per cent in H1:2024-25 (Chart I.9). index, remains upbeat on improved expectations Taking into account the baseline assumptions, survey about the general economic situation, employment, indicators and model forecasts, real GDP growth is and income conditions (Chart I.7).10 expected at 6.5 per cent in 2023-24 – 6.5 per cent In the Reserve Bank’s industrial outlook survey in Q2; 6.0 per cent in Q3; and 5.7 per cent in Q4 – of July-September 2023, manufacturing firms are with risks evenly balanced around this baseline path Chart I.8: Business Assessment and Expectations a. Manufacturing Firms b. Services Firms c. Infrastructure Firms Sources: Industrial Outlook Survey; and Services and Infrastructure Outlook Survey, RBI. 10 The Reserve Bank’s consumer confidence survey is being conducted in 19 cities since March 2021 (13 cities in the previous rounds) and the results of the September 2023 round are based on responses from 6,077 respondents. 9Monetary Policy Report October 2023 Table I.4: Business Expectations Surveys Chart I.10: Projection of Growth in Real GDP (y-o-y) Item NCAER FICCI Dun and CII Business Overall Bradstreet Business Confidence Business Composite Confidence Index (July Confidence Business Index 2023) Index Optimism (September (August Index 2023) 2023) (September 2023) Current level of 128.0 64.8 70.0 67.1 the index Index as per 149.7 62.5 73.1 66.1 previous survey % change (q-o-q) -14.5 3.7 -4.2 1.6 sequential % change (y-o-y) -7.6 -0.3 0.2 7.8 Note: The fan chart depicts uncertainty around the baseline projection Notes: path. The baseline projections are conditioned upon the assumptions set out in Table I.2. The thick green shaded area represents 50 per cent confidence 1. NCAER: National Council of Applied Economic Research. interval, implying that there is 50 per cent probability that the actual outcome 2. FICCI: Federation of Indian Chambers of Commerce & Industry. will be within the range given by the thick green shaded area. Likewise, for 3. CII: Confederation of Indian Industry. 70 per cent and 90 per cent confidence intervals, there is 70 per cent and 90 4. Dun and Bradstreet Composite Business Optimism Index and CII per cent probability, respectively, that the actual outcomes will be in the range Business Confidence Index are for Q2:2023-24 and data for the rest represented by the respective shaded areas. Source: RBI staff estimates. pertain to Q1:2023-24. Sources: NCAER; FICCI; CII; and Dun & Bradstreet Information Services India Pvt. Ltd. There are upside and downside risks to this baseline growth path. The upside risks emanate from a (Chart I.10 and Table I.3). For 2024-25, assuming a stronger-than-expected rebound in contact-intensive normal monsoon and no major exogenous or policy services, some of which have still to catch up to shocks, structural model estimates indicate real GDP their pre-pandemic levels; a more vigorous boost growth at 6.5 per cent, with quarterly growth rates in to private investment from government’s capex the range of 6.3-6.6 per cent. push and healthier corporate balance sheets; more resilient global growth; and an early resolution of the Chart I.9: Professional Forecasters' Projection of geopolitical conflict. On the contrary, an escalation Real GDP Growth in geopolitical tensions, a further hardening of international crude oil, food and commodity prices, a sharper loss of momentum in global trade and demand, and frequent weather-related disturbances due to climate change pose downside risks to the baseline growth path. I.4 Balance of Risks The projections of growth and inflation presented in this chapter are contingent upon the baseline assumptions set out in Table I.2. These assumptions remain subject to a range of uncertainties as elucidated earlier. Against this backdrop, this section explores plausible alternative scenarios to assess the balance of Source: Survey of Professional Forecasters, RBI; and National Statistical Office. risks to the baseline projections. 10Chapter I Macroeconomic Outlook (i) Global Growth Uncertainties horizon, protracted geopolitical hostilities, supply chain fragmentations and substantive slowdown in Global growth is slowing after a relatively strong China. Global inflation, though moderating, remains outturn in H1:2023. There are downside risks to the baseline assumption from the elevated inflation hostage to the risk of a wage-price spiral owing to trajectory in major economies, an extended phase tight labour markets in several AEs. There is a strong of tight financial conditions from expectations of common global component in headline and core interest rates remaining elevated over a prolonged inflation across countries (Box I.2), which could exert Box I.2: Inflation Co-movements and Idiosyncrasies: A Cross-Country Analysis The sharp rise in global commodity prices, the widespread component whereas is the idiosyncratic (i.e., country- supply chain disruptions caused by the pandemic and specific) component of inflation. The common component the conflict in Ukraine, and strong demand due to large captures the impact of a common global shock or factor monetary and fiscal stimulus led to an upsurge in inflation on country-level inflation filtered through country across geographies in 2022 (Chart I.2.1a and b). Structural loadings represented by the lag polynomial (Forni et factors such as movements in international trade and al., 2000). The global component is the weighted average financial flows and more integrated supply chains added of the common component of the sample economies, with to the synchronisation of inflation (Ha et al., 2019). To the weights being their respective shares in the aggregate empirically assess the role of such global (common) GDP at market exchange rates. The empirical analysis factors, a Generalised Dynamic Factor Model (GDFM) indicates that the share of the global component12 in the is estimated for headline as well as core inflation for a variance of inflation is (i) higher for AEs than EMEs (both sample of 26 countries11 including both AEs and emerging for headline and core) on the one hand and (ii) higher market economies (EMEs) for the period January 2012- for headline than core inflation on the other (Chart I.2.2 May 2023 (Equation 1 below). a and b). Thus, the co-movement in inflation is stronger ... (1) in AEs relative to EMEs and in headline inflation relative where is headline or core inflation of country i at time to core. The share of variance explained by the global t; the multiplicative term represents the common common factor for core inflation was muted in the pre- Chart I.2.1: Headline and Core Inflation a. Headline Inflation b. Core Inflation Sources: RBI staff estimates; CEIC; IMF. (Contd.) 11 The sample AE countries are: Canada, Czech Republic, European Union, Israel, Japan, Norway, Singapore, South Korea, Sweden, Switzerland, Taiwan, United Kingdom and United States. The sample EMEs are: Brazil, Colombia, Hungary, India, Indonesia, Mexico, Nigeria, Peru, Philippines, Russia, Romania, South Africa and Thailand. 12 Based on 36-month moving average. 11Monetary Policy Report October 2023 Chart I.2.2: Share of Common Component in Headline and Core Inflation in AEs and EMEs a. Share of Common Component in Headline Inflation b. Share of Common Component in Core Inflation Source: RBI staff estimates. pandemic period but has surged in the pandemic phase Table I.2.1: Factors Driving the Common Component and remains elevated. in Headline and Core Inflation A deep dive into the potential determinants shows that Headline Inflation Core Inflation the global component is highly persistent and driven by (1) (2) (3) (4) (5) (6) international crude prices, global food inflation and US Global EMEs AEs Global EMEs AEs dollar appreciation for headline as well as core inflation, Dependent 0.940*** 0.943*** 0.940*** 0.992*** 0.990*** 0.992*** variable, lag (0.011) (0.011) (0.011) (0.008) (0.008) (0.008) and for AEs as well as EMEs. The volatility in financial Crude 0.058*** 0.027*** 0.065*** 0.020* 0.013** 0.021* markets – represented by the VIX – is a significant driver Inflation (0.015) (0.008) (0.017) (0.011) (0.006) (0.012) of the common component of core inflation, but not Food Inflation 0.061*** 0.030*** 0.068*** 0.051*** 0.028*** 0.057*** of headline inflation. Shocks to global crude and food (0.016) (0.008) (0.018) (0.012) (0.006) (0.013) prices and the US dollar have stronger impact on the Dollar 0.038*** 0.021*** 0.041*** 0.029*** 0.020*** 0.031*** Appreciation (0.009) (0.004) (0.010) (0.007) (0.003) (0.007) common component of headline inflation than that of Metal Price -0.016 -0.008 -0.018 -0.001 -0.004 0.000 core inflation (Table I.2.1). (y-o-y) (0.016) (0.008) (0.017) (0.011) (0.006) (0.013) References: VIX (y-o-y) -0.001 -0.000 -0.002 0.012** 0.009*** 0.013* (0.008) (0.004) (0.009) (0.006) (0.003) (0.007) Forni, M., Hallin,M., Lippi, M., and Reichlin, R. (2000), Constant 0.008 0.003 0.009 0.014** 0.006** 0.015** “The Generalized Dynamic-Factor Model: Identification (0.007) (0.004) (0.008) (0.005) (0.003) (0.006) and Estimation”, The Review of Economics and Statistics, Adj. R2 0.990 0.989 0.990 0.995 0.994 0.995 Vol. 82, pp. 540-554. Observations 136 136 136 136 136 136 Standardized values of independent variables; standard errors in Ha, J., Kose, M. A., and F. Ohnsorge (2019): Inflation in parentheses. Emerging and Developing Economies: Evolution, Drivers, * p < 0.10, ** p < 0.05, *** p < 0.01 Source: RBI staff estimates. and Policies, Washington, DC: World Bank. sustained upward inflation pressures and necessitate Conversely, if inflation in major economies retreats further monetary tightening which, in turn, could faster than anticipated, geopolitical tensions ebb weigh down on output. In such a scenario, if global and the stimuli measures are able to reverse the growth is 100 bps lower than the baseline, domestic slowdown in the Chinese economy quickly, global growth and inflation could be around 30 bps and 15 growth may remain resilient. In this scenario, if bps, respectively, below their baseline trajectories. global growth is higher by 50 bps, domestic growth 12Chapter I Macroeconomic Outlook Chart 1.11: Impact of Risk Scenarios on the Baseline Inflation Path a. Crude Oil Prices and Global Demand Shocks b. Exchange Rate and Food Price Shocks Source: RBI staff estimates. and inflation could edge higher by around 15 bps and crude prices. Assuming crude oil price to be 10 per 7 bps, respectively (Charts I.11a and I.12a). cent above the baseline, domestic inflation and growth could be higher by 30 bps and weaker by around (ii) International Crude Oil Prices 15 bps, respectively. Conversely, a de-escalation of Global crude oil prices have remained highly volatile geopolitical tensions, improved supply from non- over the past six months. An escalation of geopolitical OPEC producers and alternative energy sources, hostilities and further production cuts by OPEC plus and a further weakening of global demand owing to amidst strong demand pose upside risks to global aggressive monetary policy actions by central banks Chart 1.12: Impact of Risk Scenarios on the Baseline Growth Path a. Crude Oil Prices and Global Demand Shocks b. Exchange Rate and Food Price Shocks Source: RBI staff estimates. 13Monetary Policy Report October 2023 may pull down crude oil prices. If crude oil prices fall record, and water reservoir levels have dipped below by 10 per cent relative to the baseline and assuming the decadal average levels. These developments their full pass-through to domestic product prices, impart a heightened uncertainty to the kharif and the inflation could ease by around 30 bps with a boost of ensuing rabi crops. The global food price outlook is also 15 bps to growth (Charts I.11a and I.12a). subject to significant upside risks from the historically unprecedented heatwave sweeping across the globe. (iii) Exchange Rate All these developments could impart sizeable upside The INR has fluctuated in both directions against the to the domestic food inflation trajectory and could US dollar over the past six months. Looking ahead, raise headline inflation by around 100 bps over the the ‘higher for longer’ interest rate scenario in the US baseline. On the other hand, given the robust kharif and other AEs could keep risk aversion towards EME sowing, improved irrigation facilities, the IOD turning assets elevated and impinge upon capital flows. Global positive, ample foodgrains buffer stocks and effective foreign direct investment flows are also slowing. Crude supply management could help ease food inflationary oil and other commodity prices could harden over the pressures and pull headline inflation 50 bps below the baseline. Should the INR depreciate by 5 per cent over baseline (Charts I.11b and I.12b). the baseline, inflation could edge up by around 35 I.5 Conclusion bps while GDP growth could be higher by around 25 bps through stimulating exports. On the other hand, Economic activity in India is expected to remain backed the Indian economy remains the bright spot in the up by strong macroeconomic fundamentals. Large global economy and is pivotal to the global outlook. supply shocks are, however, leading to recurrent bouts These developments, along with a strengthening of inflation and pose challenge to the overall outlook. of domestic macroeconomic fundamentals, could The uneven south-west monsoon, El Niño formation enhance India’s attraction as a destination for foreign and the volatile global food prices outlook impart investors. In this scenario, if the INR appreciates by significant uncertainty to the outlook of food and 5 per cent relative to the baseline, inflation and GDP headline inflation, even as core inflation is showing growth could moderate by around 35 bps and 25 bps, some signs of easing. Thus, price developments respectively (Charts I.11b and I.12b). warrant heightened vigil and monetary policy remains focused on aligning inflation with the target. A firm (iv) Food Inflation anchoring of inflationary expectations can pave Food inflation exhibited sizeable volatility in H1:2023- the path for sustained growth in the medium-term. 24, driven by large shocks to vegetable prices due to Geopolitical hostilities, stubborn global inflation, extreme weather events which are occurring more volatile global financial markets and energy prices, frequently and with more force. The risk of El Niño and climate shocks are the key risks to the growth and has materialised, resulting in the driest August on the inflation outlook. 14II. Prices and Costs Headline inflation has been undergoing considerable volatility, breaching the upper tolerance band of 6 per cent in July-August, due to repeated supply side shocks even as core inflation has been moderating. Industrial and farm input price pressures have eased while nominal rural wage growth has been firming up. Going forward, the inflation trajectory will be shaped by weather conditions and the evolution of global food and crude oil prices. Since the April 2023 MPR, consumer price index (CPI) has eased between February and August 2023 by 1.3 headline inflation1 has seen considerable volatility, percentage points (Chart II.1). moving in a wide range of 4.3 per cent to 7.4 per cent The Reserve Bank of India (RBI) Act enjoins the RBI to during February-August 2023. It initially moderated set out deviations of actual inflation outcomes from from 6.4 per cent in February 2023 to 4.3 per cent in projections, if any, and the underlying reasons thereof. May 2023. These gains were reversed from June on The April 2023 MPR had projected inflation at 5.1 per accentuation of food price pressures, and headline cent for Q1:2023-24 and 5.4 per cent for Q2 (Chart II.2). inflation surged to 7.4 per cent in July. In August, the In Q1, actual inflation at 4.6 per cent trailed projection onset of vegetable price correction softened it to 6.8 by 50 basis points (bps), as food inflation turned out per cent. Core inflation (CPI excluding food and fuel)2 to be lower than anticipated due to a muted seasonal pick-up in vegetables prices during April-May and a sustained decline in prices of edible oil. In Q2 (July- Chart II.1: CPI Inflation (y-o-y) August), on the other hand, the actual outcome at 7.1 16 per cent exceeded the projection by 170 bps due to 14 a steep rise in vegetables prices, particularly those of 12 tomatoes. In fact, vegetable prices and even overall nt10 9.2 food prices registered the highest month over month e c Per 8 6.8 increase in the current CPI series (2012=100) in July, 6 4.9 resulting in the projection error. 4 4.3 II.1 Consumer Prices 2 During H1:2023-24, headline inflation movements 0 Aug-21 Sep-21 Oct-21 Nov-21 Dec-21 Jan-22 Feb-22 Mar-22 Apr-22 May-22 Jun-22 Jul-22 Aug-22 Sep-22 Oct-22 Nov-22 Dec-22 Jan-23 Feb-23 Mar-23 Apr-23 May-23 Jun-23 Jul-23 Aug-23 b ave en re af git ined g of nro e m p ers ct er no tn ag g e f pav oo inu tr a db ule r inb ga s Me are cf hf -e Mct as y3 Toleranceband Fuelandlight 2023, which pulled down headline inflation from Headline CPIexcludingfoodandfuel Foodandbeverages Target 6.4 per cent in February to 4.3 per cent in May. Sources: National Statistical Office (NSO); and RBI staff estimates. Thereafter, a pick-up in the price momentum, 1 Headline inflation is measured by year-on-year (y-o-y) changes in the all-India consumer price index (CPI) produced by the National Statistical Office (NSO). 2 Core CPI, i.e., CPI excluding food and fuel is worked out by eliminating the groups ‘food and beverages’ and ‘fuel and light’ from the headline CPI. 3 A change in CPI year-on-year (y-o-y) inflation between any two months is the difference between the current month-on-month (m-o-m) change in the price index (momentum) and the m-o-m change in the price index 12 months earlier (base effect). For more details, see Box I.1 of the MPR, September 2014. 15Monetary Policy Report October 2023 alongside waning base effects led to an uptick in Chart II.2: CPI Inflation (y-o-y): Projection versus Actual headline inflation to 4.9 per cent in June. In July, an all-time high momentum in food prices (5.7 per cent) and strong momentum in fuel (1.8 per cent) led to a record monthly momentum of 290 bps in headline inflation, pushing the y-o-y inflation to 7.4 per cent. In August, a decline in momentum, along with favourable base effects helped soften inflation to 6.8 per cent (Chart II.3). The CPI inflation distribution during 2023 vis-à-vis the earlier years was marked by a significant increase in standard deviation, mirroring the large variation in inflation rates, even as the mean of the distribution *: Projections for Q2:2023-24 vis-a-vis actual average inflation for July-August 2023. fell to 5.8 per cent in 2023 (January-August) from Sources: NSO; and RBI staff estimates. 6.8 per cent in the corresponding period of 2022 Chart II.3: CPI Inflation – Momentum and Base Effects a: CPI Headline b: CPI Food and Beverages c: CPI Fuel and Light d: CPI excluding Food and Fuel 4.0 3.0 2.0 0.2 1.0 0.6 0.4 0.0 -1.0 -2.0 -3.0 -4.0 Sources: NSO; and RBI staff estimates. 16 stniopegatnecreP 12-guA 12-peS 12-tcO 12-voN 12-ceD 22-naJ 22-beF 22-raM 22-rpA 22-yaM 22-nuJ 22-luJ 22-guA 22-peS 22-tcO 22-voN 22-ceD 32-naJ 32-beF 32-raM 32-rpA 32-yaM 32-nuJ 32-luJ 32-guA 8 7.1 7 6.2 6.2 6 5.4 5.1 5 4.6 4 3 2 Q4:2022-23 Q1:2023-24 Q2:2023-24* tnec reP April 2023MPRPath ActualsChapter II Prices and Costs Chart II.4: Average CPI Inflation (y-o-y) Chart II.5: CPI Sub-Group/Group Inflation Range (Kernel Density Estimates) (y-o-y) Note: The imputed CPI prints for April and May 2020 have been regarded as a break in the CPI series. Sources: NSO; and RBI staff estimates. Sources: NSO; and RBI staff estimates. (Chart II.4). Inflation variability increased substantially narrowing of the spread of price increases across across the CPI sub-groups during July-August 2023 the CPI basket, driven largely by prices of goods following the vegetable price shock (Chart II.5). (Chart II.6a). Moreover, unlike a year ago when price Diffusion indices (DIs)4 softened during March-May increases in excess of 4 per cent on a seasonally 2023 as the fall in inflation was accompanied by a adjusted annualised rate (saar) basis were the norm Chart II.6: CPI Diffusion Indices (M-o-M Seasonally Adjusted) a: CPI Headline, Goods and Services b: CPI Headline by Thresholds Sources: NSO; and RBI staff estimates. 4 The CPI diffusion index, a measure of dispersion of price changes, categorises items in the CPI basket according to whether their prices have risen, remained stagnant or fallen over the previous month. The higher the reading above 50, the broader is the expansion or generalisation of price increases; the further is the reading below 50, the broader is the price decline across items. 17Monetary Policy Report October 2023 across the CPI basket, there was a marked slowdown in remaining one-fourth. By August, the contribution the magnitude of price increases since March 2023 as of goods to overall inflation rose to 81 per cent measured by threshold DI5 (Chart II.6b). During June- (Chart II.7b). Within goods, perishable items (non- August, the diffusion of price increases broadened durable with a 7-day recall7), particularly fruits, across goods and services, though a majority of items vegetables, and other food items such as eggs, meat, registered price increases of less than 4 per cent on a fish and milk were the main drivers. The contribution saar basis. of semi-perishable items (non-durable goods with a II.2 Drivers of Inflation 30-day recall) such as petroleum products, household items (particularly, washing soaps and powders), A historical decomposition of inflation using a personal care items (like toiletries) and medicines vector autoregression (VAR)6 model indicates that declined from 46 per cent in March 2023 to 29 per the moderation in inflation in Q1:2023-24 came cent in August. Similarly, the contribution of durables from a waning of supply side shocks as also from the (goods with a 365-day recall) like clothing and footwear disinflation engendered by the transmission of past items, motor cycle/scooter, and household goods monetary policy actions. Of the 270 bps moderation in (furniture and electronic items) to overall inflation headline inflation (from 7.3 per cent in April-June 2022 declined to 9 per cent in August 2023 from 14 per cent to 4.6 per cent in April-June 2023), 130 bps was due in March 2023. to monetary policy tightening (a cumulative increase of 250 bps in the policy rate) and the remaining 140 With the gradual moderation in the international bps was due to the waning of supply shocks. The commodity prices since September 2022, the jump in inflation in Q2:2023-24 (up to August) was contribution of imported components8 to headline entirely due to adverse supply shocks even though the inflation turned negative towards the end of 2022, restraining effects of cumulative monetary tightening driven down by the y-o-y fall in the prices of edible were still playing out (Chart II.7a). oils, energy, electronic goods parts, and polymer (Chart Goods inflation (with a weight of 76.6 per cent II.7c). With the pick-up in the global commodity prices in overall CPI) contributed around three-fourths in July 2023, primarily driven by energy prices, the of headline inflation during March-May 2023 negative contribution of imported inflation lessened and services (with a weight of 23.4 per cent) the to (-)1.2 per cent in August. 5 Threshold diffusion indices capture the dispersion of price increases in CPI basket beyond the specified saar thresholds of 4 per cent and 6 per cent. 6 Historical decomposition estimates the contribution of each shock to the movements in inflation over the sample period (Q4:2010-11 to Q2:2023-24) based on a vector autoregression (VAR) with the following variables (represented as the vector Y) – crude oil prices (US$ per barrel); exchange rate (INR t per US$), asset price (BSE Sensex), CPI; the output gap; rural wages; the policy repo rate; and money supply (M). All variables other than policy repo rate 3 are y-o-y growth rates. The VAR can be written in reduced form as: Y =c + A Y + e; where e represents a vector of shocks. Using Wold decomposition, t t-1 t t Y can be represented as a function of its deterministic trend and sum of all the shocks e. This formulation facilitates decomposition of the deviation of t t inflation from its deterministic trend into the sum of contributions from various shocks. 7 The CPI weighting diagrams use the modified mixed reference period (MMRP) data based on the 2011-12 Consumer Expenditure Survey conducted by the National Sample Survey Office (NSSO). Under MMRP, data are collected on expenditures incurred for frequently purchased items – edible oil, eggs, fish, meat, vegetables, fruits, spices, beverages, processed foods, pan, tobacco and intoxicants – during the last seven days; for clothing, bedding, footwear, education, medical (institutional), durable goods, during the last 365 days; and for all other food, fuel and light, miscellaneous goods and services including non-institutional medical services, rents and taxes, data relate to the last 30 days. 8 Global commodities that drive domestic prices include petroleum products, coal, electronic goods, gold, silver, chemical products, metal products, textiles, cereals, milk products, and vegetables oils – these together have a weight of 36.4 per cent in the CPI basket. 18Chapter II Prices and Costs Chart II.7: Drivers of CPI Inflation a: Decomposition of CPI Inflation* * Deviation from deterministic trend. Note: Estimated using a vector autoregression (see footnote 6 for details). Q2:2023-24 pertains to July-August 2023. Sources: NSO; RBI; Petroleum Planning & Analysis Cell (PPAC); BSE; Labour Bureau; and RBI staff estimates. b: Contribution of Goods and Services c: Contribution of Imported Inflation * Represent balancing term between CPI item indices aggregated vertically and the published overall CPI index. Note: Figures in parentheses indicate weights in CPI. Sources: NSO; and RBI staff estimates Food Group pulses, and spices remained elevated. Inflation in oils and fats remained in deflation, partially offsetting Food and beverages (weight of 45.9 per cent in the the upside pressures across other major sub-groups CPI basket) inflation, which was muted in Q1:2023- in the food basket (Chart II.8). The sharp increase in 24 at 4.1 per cent, increased sharply to 10.6 per cent vegetables prices in July was due to supply disruptions in July, led by the steep increase in vegetables prices. With corrections in the vegetable prices on fresh crop caused by heavy rainfall and floods in the northern arrivals, food inflation moderated to 9.2 per cent parts of the country and lower production due to in August. CPI food inflation excluding vegetables, pest attacks on crops in Karnataka and Maharashtra. however, increased to 6.4 per cent during July-August Uneven rainfall distribution, delayed sowing of rice, from 5.4 per cent in Q1 as inflation in respect of cereals, and lower stock of wheat along with lower production 19Monetary Policy Report October 2023 Chart II.8: CPI Food Inflation a: Drivers of CPI Food Inflation b: Drivers of CPI Food Momentum * Includes meat and fish, egg, milk and pulses. ** Includes fruits, sugar, non-alocoholic beverages and prepared meals. Note: Figures in parentheses indicate weights in CPI food and beverages. Sources: NSO; and RBI staff estimates. of spices contributed to the hardening of prices in prepared meals; non-alcoholic beverages; and eggs – cereals and spices. were lower than their long-term averages (Chart II.9). The overall food price build-up in 2023-24 was higher Inflation in cereals (weight of 9.7 per cent in the than historical patterns, driven by vegetables, spices, CPI and 21.1 per cent in the food and beverages pulses, sugar and cereals. The price build-ups in six of group) remained elevated during April-August 2023 the twelve sub-groups – fruits; meat and fish; milk; (Chart II.10). After a decline between March and May Chart II.9: Financial Year Price Build-up Chart II.10: Cereals Inflation (y-o-y) (August over March) Note: Figures in parentheses indicate weights in CPI - food and beverages. Sources: NSO; and RBI staff estimates. Sources: NSO; and RBI staff estimates 20Chapter II Prices and Costs 2023, wheat prices surged as rabi wheat crop was Chart II.11: Drivers of Vegetable Inflation (y-o-y) impacted by unseasonal rains. Rice prices increased sharply as uneven rainfall distribution led to delay in kharif sowing. However, sowing eventually picked up (1.9 per cent over last year as on September 29, 2023) on account of revival in monsoon. As part of the supply side interventions to improve domestic supply and ease price pressures, the Government (i) announced to release a cumulative 5 million tonnes of wheat and 2.5 million tonnes of rice in the open market in a phased manner; (ii) imposed an export duty on parboiled rice, restricted exports of non- basmati rice and levied stock limits on wheat; and (iii) stopped the diversion of subsidised rice to distilleries for ethanol production. Note: Figures in parentheses indicate items' weights in CPI-vegetables. Sources: NSO; and RBI staff estimates. After being in deflation during November 2022-June 2023, prices of vegetables (weight of 6.0 per cent in the CPI and 13.2 per cent in the food and beverages group) TOP – ginger, garlic, cauliflower, cabbage, brinjal and increased sharply to record a y-o-y inflation of 37.4 per green chillies – also witnessed high price pressures cent in July 2023, due to weather related crop damage in July due to rain induced supply disturbances. and disrupted supply chains in North India. A pick- The price build-up in non-TOP vegetables during up in market arrivals and improved supply conditions 2023-24 (up to August) was unprecedented by caused inflation in this category to moderate to 26.1 historical patterns and contributed substantially per cent in August (Chart II.11). to the spike in vegetables inflation (Chart II.12b). With the improving supply situation, the prices of Among key vegetables, tomato prices, on a y-o-y vegetables excluding TOP corrected in August. To rein basis, surged by 202.1 per cent in July. A revival in in prices, the government announced sale of tomatoes market arrivals moderated tomato price inflation to at concessional rates at several markets in the country 180.3 per cent in August 2023. Potato prices have during July-August 2023 and release of onions (under remained in deflation since February 2023 on account the Price Stabilisation Fund) at subsidised rates from of higher production last year (an increase of 6.3 per the buffer stocks. cent in 2022-23 as per 1st advance estimates (AE) over 2021-22). Onion prices, which were in deflation during Inflation in fruits (weight of 2.9 per cent in the CPI September 2021-May 2023, recorded an inflation of and 6.3 per cent within the food and beverages group) 23.2 per cent in August 2023 on lower production [(-) has moderated since April 2023 on the back of higher 2.1 per cent in 2022-23 1st AE over 2021-22] as well as production (0.2 per cent as per 2022-23 1st AE over low quality of the rabi crop reducing shelf life. Overall, 2021-22). However, there was an uptick in inflation in the record price increase in July propelled the tomato, July-August 2023, primarily driven by a rise in apple onion, and potato (TOP) group price build-up (July- prices to 21.3 per cent (y-o-y) in August from an average August over March) to one of the largest ever seen in the of 5.1 per cent in Q1:2023-24 as floods in Himachal current CPI series (Chart II.12a). Vegetables excluding Pradesh damaged apple plantations and led to supply 21Monetary Policy Report October 2023 Chart II.12 : Price build-up in CPI Vegetables a: CPI TOP* b: CPI Vegetables excluding TOP *: TOP denotes tomatoes, onions and potatoes. Sources: NSO; and RBI staff estimates. disruptions. Mango prices remained in deflation since masoor under the Price Support Scheme (PSS) for April 2023, while banana price inflation moderated 2023-24 to encourage higher sowing acreage; and (iii) from 21.8 per cent in March 2023 to 2.2 per cent in decided to release tur from the national buffer in a August on the back of comfortable production. calibrated manner. Inflation in pulses (weight of 2.4 per cent in the CPI Prices of animal-based protein items increased and 5.2 per cent in the food and beverages group) sharply in H1:2023-24 (April-August), driven by milk increased gradually, with a substantial price build-up from April leading to a print of 13.0 per cent in August Chart II.13: CPI Pulses and Products 2023. The uptick came from lower production and (Price build-up) deficient kharif sowing. As per the 3rd AE of 2022-23, 12 the kharif production of pulses was lower than the final estimates for 2021-22, particularly for tur and 10 urad ((-) 18.7 per cent and (-) 3.2 per cent, respectively). 8 Owing to the downward revision, the pulses stock-to- nt e use (STU) ratio has also fallen. Furthermore, deficient Per c 6 kharif sowing of (-) 4.9 per cent in tur, (-) 1.3 per cent 4 in urad and (-) 6.0 per cent in moong (as on September 29, 2023) also added to price pressures (Chart II.13 and 2 Chart II.14). To contain price pressures and improve 0 domestic availability, the government (i) imposed Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar stock limits on tur and urad on June 2, 2023, which 2022-23 2023-24 2015-16to2021-22 will be effective till December 31, 2023; (ii) removed Sources: NSO; and RBI staff estimates. procurement ceilings of 40 per cent for tur, urad and 22Chapter II Prices and Costs Amul raised retail prices by `2-3 per litre twice from Chart II.14: Pulses Inflation and Stock-Use Ratio February 2023, citing high input costs. Prices of eggs, meat and fish eased in July-August 2023 due to low seasonal demand. Prices of oils and fats (weight of 3.6 per cent in the CPI and 7.8 per cent within the food and beverages group) were in deflation during April-August 2023, reflecting falling international prices and higher domestic production of oilseeds (8.0 per cent as per 3rd AE of 2022-23 over 2021-22) (Chart II.16). As part of price stabilisation measures, the government reduced the basic import duty on refined soyabean oil and refined sunflower oil from 17.5 per cent to 12.5 per cent (on June 15, 2023, effective till March 31, 2024) Note: Stock here refers to total available pulses for consumption from and exempted imports of crude soybean oil and crude production and net imports; with the government, farmers and open market. Sources: MOSPI; DGCI&S; CACP; Ministry of Agriculture; and RBI staff estimates. sunflower oil from basic customs duty and agriculture infrastructure and development cess (AIDC) till June and products (weight of 6.6 per cent in the CPI and 30, 2023 for tariff rate quota (TRQ) holders to ensure 14.4 per cent within the food and beverages group) domestic availability and affordable prices. Ghee and (Chart II.15) which averaged 8.5 per cent during butter price inflation remained at elevated levels, April-August 2023 as major milk co-operatives like reflecting the pass-through of higher milk prices. Chart II.15: Drivers of Animal Protein Inflation Chart II.16: Edible Oil Prices: (H1:2023-24 over H2:2022-23) Domestic and Global 3.5 40 120 1.9 3.0 30 100 3.0 ntage points 2.5 percent 12 00 468 000 percent on in perce 12 .. 50 1.2 Y-o-y, -100 -02 20 0 Y-o-y, uti -20 ontrib 1.0 -0.1 -30 -- 64 00 C 0.5 Aug-21 Sep-21 Oct-21 Nov-21 Dec-21 Jan-22 Feb-22 Mar-22 Apr-22 May-22 Jun-22 Jul-22 Aug-22 Sep-22 Oct-22 Nov-22 Dec-22 Jan-23 Feb-23 Mar-23 Apr-23 May-23 Jun-23 Jul-23 Aug-23 0 Meatand fish Egg(4) Milkand Animalprotein CPIoilsandfats (34) products (62) Globaloilsandmeals(rightscale) Note: Figures in parentheses indicate weights in CPI-animal protein group. Globalpalmoil(rightscale) H1:2023-24 refers to April-August. Sources: NSO; and RBI staff estimates. Sources: World Bank Pink Sheet; NSO; and RBI staff estimates. 23Monetary Policy Report October 2023 Inflation in prices of sugar and confectionery (weight cent in August; inflation in prices of dry chillies was of 1.4 per cent in the CPI and 3.0 per cent in the food also elevated averaging 24.2 per cent during April- and beverages group) increased gradually during August 2023. Inflation in prepared meals moderated April-August 2023, reflecting reduced production gradually, reflecting the waning of the pass-through in 2022-23 season from the earlier estimate and the of past increases in input costs such as edible oils, pickup in demand during summer months. LPG, and transport costs. Among other food items, inflation in prices of spices Retail Margins witnessed a sustained rise, averaging 19.9 per cent during April-August 2023 and driven mainly by jeera Retail price margins – the difference of retail and (cumin) and dry chillies due to subdued production wholesale prices9 – remained broadly unchanged for for the second consecutive year in 2022-23 on account cereals. Pulses price margins underwent an increase of poor weather conditions and crop substitution during July-September 2023, driven by retail prices of in major producing states. On a y-o-y basis, jeera tur, urad, moong and gram. Price margins in edible recorded the highest increase in prices at 118.2 per oils (groundnut, soyabean, sunflower and mustard Chart II.17: Retail, Wholesale Prices and Margin a: Cereals b: Pulses c: Vegetables d: Edible Oils (Packed) Sources: Department of Consumer Affairs, Ministry of Consumer Affairs, Food and Public Distribution; and RBI staff estimates. 9 Item level retail and wholesale prices are aggregated at respective subgroups using item level CPI weights. Data for January-March 2021 have been excluded due to changes in price collection mechanism and item varieties by DCA. 24Chapter II Prices and Costs oil) remained elevated and steady even as wholesale tomato prices starting the third week of August 2023, prices registered a downward movement. Margins in retail margins for vegetables softened in September vegetables prices picked up significantly during June- 2023. The sensitivity of margins to wholesale prices August 2023, owing to the sharp increase in retail in the TOP group is the highest for tomatoes and the margins in tomatoes (Chart II.17). With an easing of lowest for potatoes (Box II.1). Box II.1: Vegetable Retail Margins: Some Stylised Evidence Volatile movements in food items, especially vegetables, margins were seen to fall. From the 10th to the 100th have brought increased focus on retail margins and their percentile, the margins in tomatoes fell from 39 per behaviour in the past few years (Jose et al. 2021, Bhoi et cent to 23 per cent, in onions from 37 per cent to 17 per al. 2019). During January 2014-August 2023, margins10 cent, and in potatoes from 36 per cent to 22 per cent were the highest for tomatoes, followed by onions and (Chart II.1.1b). potatoes (Chart II.1.1a). Mapping TOP margins with the The sensitivity of retail TOP margins to changes in corresponding wholesale price levels, it is observed that wholesale prices can be assessed by regressing the TOP as wholesale prices increase, margins also rise. During July margins (expressed as ` per kg) on to their respective 2014 to August 2023, when the TOP wholesale prices rose wholesale prices (bracketed into percentiles of the from the 10th to the 100th percentile of the distribution, wholesale price distribution). For tomatoes, for each margins increased by three times for tomatoes, and two one rupee increase in wholesale prices in the lowest 10th times for onions, while the increase was low in case of percentile, margins increased by 30 paise; the increase potatoes. However, as a percentage of wholesale prices, was lower at 25 paise in the 50th percentile and 20 Chart II.1.1: TOP Retail Margins a: TOP* Margins b: TOP Margins (by Percentiles of Wholesale Prices) 14 45 40 12 35 10 30 8 25 6 20 15 4 10 2 5 0 0 10th 20th 30th 40th 50th 60th 70th 80th 90th 100th Sources: DoCA, GoI; RBI staff estimates. (Contd.) 10 Margins have been computed as the difference between retail and wholesale prices. Monthly retail and wholesale prices of TOP provided by Department of Consumer Affairs (DCA), GoI have been used for the analysis. 25 sraB-)gkrep(cid:31)(snigraM seniL-)tnecrep(snigraM Percentile *: TOP denotes tomatoes, onions and potatoes. Tomato Onion Potato margolik rep `Monetary Policy Report October 2023 paise in the 100th percentile. For onions, the sensitivity Table II.1.1: Estimates of Sensitivity of Retail Margins of margins to changes in wholesale prices was lower to Wholesale Price Levels and more stable – for each one rupee increase in the Margins (` per kg) Percentiles of wholesale prices, retail margins increased by around Wholesale Prices Tomato Onion Potato 10-12 paise across percentiles. In the case of potatoes, 10th 0.307** 0.105** -0.011 the sensitivity of margins to wholesale prices remained (0.025) (0.019) (0.033) 20th 0.292** 0.101** -0.003 largely insignificant within the 10th to 70th percentiles (0.022) (0.018) (0.031) and became significant only when the wholesale prices 30th 0.280** 0.113** 0.004 reached the highest end of the percentile distribution (0.018) (0.011) (0.028) 40th 0.262** 0.116** 0.014 (Table II.1.1). Overall, the analysis shows that margins (0.016) (0.008) (0.026) are the highest and most sensitive to wholesale price 50th 0.249** 0.117** 0.022 (0.014) (0.008) (0.025) variations in the case of tomatoes and least in the case 60th 0.242** 0.118** 0.025 of potatoes. The margin sensitivities to wholesale price (0.013) (0.007) (0.023) 70th 0.228** 0.120** 0.033 changes taper along higher percentiles of wholesale (0.011) (0.005) (0.021) prices and decline or at most remain stable, when 80th 0.210** 0.119** 0.040* expressed as a percentage of wholesale prices. (0.009) (0.004) (0.019) 90th 0.203** 0.112** 0.042** Reference: (0.008) (0.004) (0.016) 100th 0.194** 0.108** 0.040** Bhoi B.B., Kundu S., Kishore V. and Suganthi, D. (2019), (0.005) (0.002) (0.013) Constant 1.362** 3.152** 4.447** “Supply Chain Dynamics and Food Inflation in India”, RBI (0.416) (0.196) (0.417) Bulletin, October. Adj R-squared: 0.978 0.966 0.931 George A.T., Bhatia S., John J. and Das P. (2023), “An Note: ** and * indicate significance at 5 and 10 per cent levels, resepectively. Figures in parentheses indicate standard errors. The sample period for the Examination of Retail Margins”, mimeo. analysis is July 2014-August 2023. ARIMAX regression framework was used for estimation, with AR(1) and MA(1) terms included in the specifications. Jose J., Kishore V. and Bhoi B.B (2021), “COVID-19 Impact Diagnostic tests confirm no autocorrelation. Source: RBI staff estimates. on Food Price Mark-ups in India”, RBI Bulletin, August. Fuel Group Kerosene prices remained in deflation during May- August 2023 on a y-o-y basis as domestic prices fell CPI fuel inflation moderated from 8.8 per cent in line with international prices, aided by favourable in March 2023 to 3.7 per cent in July on account base effects. Firewood and chips prices also of softening of kerosene and domestic liquified petroleum gas (LPG) prices, before it rose to 4.3 moderated during March-August. Electricity prices, per cent in August. With domestic prices of LPG on the other hand, registered a substantial increase kept unchanged between March and late August, from May, leading to a record inflation (y-o-y) of the moderation came from favourable base effects. around 13.5 per cent in August (Chart II.18). 26Chapter II Prices and Costs Chart II.18: CPI Fuel Group Inflation a: Fuel Inflation (y-o-y, per cent) b: Kerosene: Domestic and International Prices c: LPG: Domestic and International Prices 1200 85 75 1000 65 kg) 800 55 4.2 1 perlitre `34 55 ercylinder( 46 00 00 25 p ` 200 15 5 0 Jan-21 Feb-21 Mar-21 Apr-21 May-21 Jun-21 Jul-21 Aug-21 Sep-21 Oct-21 Nov-21 Dec-21 Jan-22 Feb-22 Mar-22 Apr-22 May-22 Jun-22 Jul-22 Aug-22 Sep-22 Oct-22 Nov-22 Dec-22 Jan-23 Feb-23 Mar-23 Apr-23 May-23 Jun-23 Jul-23 Aug-23 Sep-23 Jan-21 Feb-21 Mar-21 Apr-21 May-21 Jun-21 Jul-21 Aug-21 Sep-21 Oct-21 Nov-21 Dec-21 Jan-22 Feb-22 Mar-22 Apr-22 May-22 Jun-22 Jul-22 Aug-22 Sep-22 Oct-22 Nov-22 Dec-22 Jan-23 Feb-23 Mar-23 Apr-23 May-23 Jun-23 Jul-23 Aug-23 Sep-23 Kerosene-International Kerosene- Domestic(subsidised) LPG- International LPG-Domestic Notes: (1) The international price for LPG is based on spot prices for Saudi Butane and Propane, combined in the ratio of 60:40 respectively. These international product prices are indicative import prices. Further details are available at www.ppac.org.in. (2) The indicative international price for kerosene is the Singapore Jet Kero spot price. (3) The domestic prices of LPG and kerosene represent the average prices of four and three metros, respectively, as reported by Indian Oil Corporation Limited (IOCL). (4) Figures in parentheses indicate items' weights in CPI-fuel and light group. Sources: NSO; Bloomberg; IOCL; and RBI staff estimates. Core (CPI excluding Food and Fuel) Reversing the generalisation and persistence observed during 2022-23, core inflation softened during 2023-24 Core inflation (CPI excluding food and fuel) (April-August), along with a lower standard deviation eased from 6.1 per cent in February 2023 to 4.9 per (Chart II.19). During April-May 2023, threshold cent during July-August. Exclusion-based measures of underlying inflation, which remove volatile items diffusion indices of core CPI items registering price such as petrol, diesel, gold, and silver also witnessed increases of greater than 6 per cent (saar) as well that moderation in the range of 130-140 bps during this of 4 per cent (saar) moved into the contraction zone, period (Table II.1). indicating some abatement in the intensity of price 27Monetary Policy Report October 2023 Table II.1: Exclusion-based Measures of Inflation Chart II.20: CPI excluding Food, Fuel, Petrol, (y-o-y) Diesel, Gold and Silver: SAAR Diffusion Index by Thresholds Period CPI excluding CPI excluding CPI excluding food food and fuel food fuel petrol fuel petrol diesel (47.3) diesel (45.0) gold silver (43.8) Aug-22 5.9 6.2 6.2 Sep-22 6.0 6.3 6.4 Oct-22 6.0 6.5 6.5 Nov-22 6.0 6.3 6.4 Dec-22 6.1 6.3 6.3 Jan-23 6.2 6.5 6.3 Feb-23 6.1 6.4 6.2 Mar-23 5.8 6.0 5.9 Apr-23 5.1 5.8 5.6 May-23 5.2 5.8 5.4 Jun-23 5.2 5.4 5.2 Jul-23 4.9 5.1 4.8 Aug-23 4.9 5.1 4.8 Note: (1) Figures in parentheses indicate weights in CPI. Sources: NSO; and RBI staff estimates. (2) Derived as residual from headline CPI. Sources: NSO; and RBI staff estimates. pressures. During June-August, the diffusion index During 2023-24 (April-August), the contribution of rebounded, but threshold core DIs for saar of greater transportation and communication and clothing and than 4 per cent and 6 per cent remained in contraction footwear sub-groups registered a significant softening (Chart II.20). (Chart II.21). Chart II.19: CPI Inflation excluding Food and Chart II.21: Contribution to CPI Inflation Fuel: Persistence excluding Food and Fuel (Percentage points) 4.8 CPI excluding foodfuel (y-o-y, per cent) 6.1 5.1 of which 0.6 Transport and communication (18.2) 1.0 0.3 Health (12.5) 00 .. 87 0.8 0.5 Clothing and footwear (13.8) 1.3 0.9 Housing (21.3) 0.91.3 1.0 0.3 Householdgoods and services (8.0) 0.6 0.4 Personal careand effects (8.2) 0. 04 .6 0.7 Education (9.4) 00 .. 55 0.5 Others* (8.6) 00 .. 45 0.4 Memo 2.1 Core goods(51.3) 3.5 2.9 2.6 Core services(48.7) 2.6 2.2 Average (2017-18to2019-20) 2022-23 2023-24(Apr-Aug) * Others include Pan, tobacco and intoxicants; and Recreation and amusement. Note: Figures in parentheses indicate weights in CPI excluding food and fuel. Sources: NSO; and RBI staff estimates. Sources: NSO; and RBI Staff estimates. 28Chapter II Prices and Costs Chart II.22: Drivers of Transportation and Communication and Personal Care and Effects Inflation a: Transportation and Communication b: Personal Care and Effects Note: Figures in parentheses indicate weights in the respective sub-group. Sources: NSO; and RBI staff estimates. The movement of petrol and diesel prices into 190 bps from 7.3 per cent in February 2023 to 5.4 deflation during Q1:2023-24, along with a softening per cent in August, services core inflation fell by in transportation fares and communication services, around 90 bps to 4.2 per cent. The key drivers of led to the sharp moderation in transportation and the softening in goods inflation were clothing and communication inflation. A firming up of gold and footwear, household goods and personal care and silver prices kept personal care and effects inflation effects (excluding gold and silver) (Chart II.23a). In and its contribution to core inflation elevated (Chart the case of services, transportation fares (bus/tram/ II.22). taxi fare, air fare) and communication services along with housing drove the moderation in inflation A decomposition of CPI excluding food, fuel, petrol, (Chart II.23b). diesel, gold, and silver inflation into its goods (with a weight of 20.7 per cent in the headline CPI) and Trimmed mean measures11 also indicate a tempering services (weight of 23.0 per cent) components shows of underlying inflation pressures, with weighted a softening in both the categories, but mainly led median inflation registering a decline of 140 bps by goods. While core goods inflation moderated by between February and August 2023 (Table II.2). 11 While exclusion-based measures drop a fixed set of volatile items (for example, food and fuel) in each period, trimmed measures exclude items located in the tails of the inflation distribution - items displaying changes more than the specified threshold in prices each month are excluded, and the items dropped differ from month to month. 29Monetary Policy Report October 2023 Chart II.23: Contributions to CPI Inflation excluding Food, Fuel, Petrol, Diesel, Gold, and Silver a: Goods b: Services * Represent balancing item to reconcile divergence in CPI index between CPI items indices aggregated vertically, across items and the published sub-group/group/overall CPI index. Note: Figures in parentheses indicate weights in CPI. Sources: NSO; and RBI staff estimates. Other Measures of Inflation (CPI-RL) as also for industrial workers (CPI-IW) exceeded CPI headline inflation during March-June Sectoral measures of CPI inflation for rural areas, i.e., 2023 across most major groups. During July-August CPI agricultural labourers (CPI-AL) and rural labourers 2023, CPI-AL, CPI-RL, and CPI-IW edged up on higher Table II.2: Trimmed Mean Measures of food prices, in line with headline CPI. Wholesale price Inflation (y-o-y) index (WPI) inflation, which was on a downward Month 5% 10% 25% Weighted trajectory since October 2022, spiralled down into trimmed trimmed trimmed Median deflation in April-August, partly offset by higher Aug-22 6.6 6.4 6.1 6.5 vegetable prices in July, and fuel prices in August. The Sep-22 6.9 6.6 6.5 6.7 Oct-22 6.8 6.6 6.6 6.6 deflation in WPI pulled down the deflators for gross Nov-22 6.5 6.5 6.5 6.6 value added (GVA) and gross domestic product (GDP) Dec-22 6.5 6.5 6.5 6.9 Jan-23 6.6 6.6 6.6 6.8 in Q1:2023-24 (Chart II.24a). Feb-23 6.6 6.5 6.5 6.6 Mar-23 6.0 6.3 6.3 6.4 Overall, WPI inflation remained far below headline Apr-23 5.1 5.6 5.9 5.7 CPI inflation during March-August 2023, driven May-23 5.1 5.6 5.7 5.5 Jun-23 5.5 5.7 5.7 5.8 down by the fuel group – CPI contains transport fuel Jul-23 6.1 6.0 5.6 5.5 Aug-23 5.7 5.6 5.3 5.2 (petrol and diesel) prices of which have remained flat since August 2022, whereas WPI contains in Sources: NSO; and RBI staff estimates. 30Chapter II Prices and Costs Chart II.24: Alternative Measures of Inflation a: Various Measures of Inflation (y-o-y) b: CPI-WPI Divergence : Select Commodities (Average y-o-y inflation during March-Aug 2023) 18 18 16 16 14 14 12 12 10 10 8 8 6 6 4 4 2 2 0 0 -2 -2 -4 -4 -6 -6 -8 -8 -10 -10 Sources: NSO; Labour Bureau; Ministry of Commerce and Industry; and RBI staff estimates. addition to petrol and diesel, other fuels such as and higher domestic production. Minerals price aviation turbine fuel, naphtha and furnace oil, all of inflation, however, recorded an uptick during July- which were by and large in deep deflation tracking August 2023 driven by metals, particularly copper, international prices. In terms of other major groups, on rising demand coupled with limited supply owing WPI inflation in food (particularly, cereals, milk and pulses), clothing and footwear, and pan, tobacco and intoxicants also ruled below the corresponding CPI groups/subgroups (Chart II.24b). II.3 Costs Costs, as measured by WPI inflation in industrial raw materials and farm inputs, entered negative territory in April-May 2023 and remained muted since then, reflecting easing international commodity prices (Chart II.25). Prices of industrial inputs such as high- speed diesel (HSD), naphtha, aviation turbine fuel (ATF), bitumen, furnace oil, and petroleum coke were in deflation during April-August, mirroring international crude oil price movements. The other contributory factors were non-food primary articles, particularly cotton and oilseeds, whose prices declined due to lower international prices 31 tnec reP 12-guA 12-peS 12-tcO 12-voN 12-ceD 22-naJ 22-beF 22-raM 22-rpA 22-yaM 22-nuJ 22-luJ 22-guA 22-peS 22-tcO 22-voN 22-ceD 32-naJ 32-beF 32-raM 32-rpA 32-yaM 32-nuJ 32-luJ 32-guA stniopegatnecreP CPI-WPI gap(rightscale) WPI CPI-IW CPI-AL CPI-RL CPI GVAdeflator GDPdeflator Chart II.25: Farm and Non-farm Input Cost Inflation (y-o-y) 45 40 35 30 25 20 15 10 5 -0.5 0 -4.5 -5 -10 -5.7 -15 *: Comprise primary non-food articles, minerals, coal, aviation turbine fuel, high speed diesel, naphtha, bitumen, furnace oil, lube oil, petroleum coke, electricity, cotton yarn and paper and pulp from WPI. $: Comprise high speed diesel, fodder, electricity, fertilisers, pesticides, and agricultural and forestry machinery from WPI. Sources: Ministry of Commerce and Industry; and RBI staff estimates. tnec reP 12-guA 12-peS 12-tcO 12-voN 12-ceD 22-naJ 22-beF 22-raM 22-rpA 22-yaM 22-nuJ 22-luJ 22-guA 22-peS 22-tcO 22-voN 22-ceD 32-naJ 32-beF 32-raM 32-rpA 32-yaM 32-nuJ 32-luJ 32-guA Overall WPI Industrialrawmaterials* Farminputs$Monetary Policy Report October 2023 to constraints on new mining projects worldwide, Chart II.26: Wage Growth (y-o-y) and Inflation in increased taxes and environmental regulations. Farm Rural Areas (y-o-y) input price inflation receded and turned negative from May 2023, driven by moderation in the prices of HSD and pesticides. Inflation in the price of WPI electricity – a key input in both industrial and farm inputs – declined sharply post April 2023 on account of a substantial decrease in coal prices coupled with favourable base effects. Nominal rural wage growth accelerated to 6.6 per cent in July 2023 from 5.7 per cent in March 2023, with both agricultural and non-agricultural wages rising by more than 6 per cent (Chart II.26). While the increase *: comprise ploughing, sowing, harvesting, picking, horticulture workers, fishermen, fishermen costal, loggers and wood cutters, animal husbandry, in agricultural wage growth was recorded primarily packaging, general agriculture labourers, plant protection workers. **: comprise carpenter, blacksmith, mason, weavers, beedi makers, bamboo- in ploughing, picking works, horticulture, watering cane basket weavers, handicraft workers, plumbers, electrician, construction workers, LMV & tractor drivers, sweeping/cleaning workers, and other non- and irrigation works, packaging, and plant protection agricultural labourers. Note: Data for April-May 2021 were not released. works, that in non-agricultural wages were broad Sources: NSO; Labour Bureau; and RBI staff estimates. based across the rural sector. In the organised sector, staff cost growth (y-o-y) due to a strong favourable base effect. The share quickened in Q1:2023-24 in the manufacturing of staff cost in the value of production rose in sector. In the services sector, staff cost growth (y-o-y) Q1 for both manufacturing and services sectors decelerated, notwithstanding positive momentum, (Chart II.27). Chart II.27: Staff Cost in Manufacturing and Services a: Manufacturing Sector b: Services Sector Baseeffect Quarterlymomemtum Staff cost growth (y-o-y) Staff cost/value of production (right scale) Note: Staff cost growth (y-o-y) is based on a common set of companies. Sources: Capitaline database; and RBI staff estimates. 32Chapter II Prices and Costs Chart II.28: Expectations of Cost and Price Conditions a: Salary Outgo b: Cost of Inputs c: Selling Prices Note: ‘Net response’ is the difference between the percentage of respondents reporting increase and those reporting decrease. Sources: Reserve Bank’s Industrial Outlook Survey; Services & Infrastructure Outlook Survey; and RBI staff estimates. As per the firms polled in the Reserve Bank’s to moderate in Q3 for services and infrastructure enterprise surveys12, the pace of salary outgoes sectors. Manufacturing firms expect an uptick for the manufacturing, infrastructure and services in input prices in Q3, with selling price growth sectors is expected to moderate in Q3:2023-24. Both to be marginally lower over the previous quarter input cost pressures and selling prices are expected (Chart II.28). Chart II.29: PMI Input-Output Price Gap a: Manufacturing Sector b: Services Sector 70 9 8 65 7 6 60 5 4 55 3 2 50 1 45 0 -1 40 -2 Sources: S&P Global; and RBI staff estimates. 12 Industrial Outlook Survey; and Services and Infrastructure Outlook Survey. 33 )egnahcoN=05,detsujdayllanosaes(xednI 12-raM 12-yaM 12-luJ 12-peS 12-voN 22-naJ 22-raM 22-yaM 22-luJ 22-peS 22-voN 32-naJ 32-raM 32-yaM 32-luJ 32-peS paGxednI Input-output price gap(rightscale) Inputprices Output pricesMonetary Policy Report October 2023 One year ahead business inflation expectations13 of II.4 Conclusion firms polled by the Indian Institute of Management, Climate events imparted substantial volatility to the Ahmedabad, remained stable at 4.3 per cent during inflation trajectory in H1:2023-24. Going forward, the July-August 2023 with a moderate rise in cost overall inflation and the food inflation trajectory will pressures and improvement in sales expectations. likely be shaped by the intensity of El Niño conditions, As per manufacturing firms polled for the purchasing the impact of the skewed south-west monsoon and managers’ index (PMI), the pace of increase in input global energy and food prices. prices which quickened for the third successive month Pro-active supply side measures assume importance in August 2023, significantly retreated in September in mitigating the adverse impact of supply shocks in due to reduction in aluminium and oil prices. Higher the short-run. Medium-term policies to encourage raw materials, labour costs and increased demand crop diversification, promote climate-resilient crops, led to an increase in output prices in July-September improve storage conditions, facilitate value addition albeit at a slower pace than in May-June 2023. For in agriculture and augment agricultural supply chains services sector, the pace of increase in input prices started to fall in August-September 2023 converging would make food prices more resilient to climate towards its long-run average which also led to easing vagaries. Monetary policy would persevere in its in prices charged to a six-month low. The input- efforts to maintain price stability, to progressively output price gap reversed for manufacturing sector in align inflation with the target rate, thereby securing September 2023 while it narrowed for services sector. the prerequisite conditions for a high and sustainable (Chart II.29). growth over the medium term. 13 Based on the monthly Business Inflation Expectations Survey (BIES) of the Indian Institute of Management, Ahmedabad. The survey polls a panel of business leaders primarily from the manufacturing sector about their inflation expectations in the short and medium term. 34III. Demand and Output Domestic economic activity held up well in H1:2023-24, underpinned by private consumption and investment activity. The sustained buoyancy in services, consumer and business optimism, government’s continued thrust on capex, and healthy balance sheets of banks and corporates brighten the outlook. Geopolitical tensions, geoeconomic fragmentation, signs of a global economic slowdown and El Niño conditions pose risks. Underpinning the resilience of domestic economic III.1 Aggregate Demand activity in H1:2023-24, private consumption was Aggregate demand conditions exhibited buoyancy driven by stable urban demand and a gradual with real gross domestic product (GDP) posting a revival in rural demand. Investment activity gained growth of 7.8 per cent (year-on-year, y-o-y) in Q1:2023- traction from sustained government capex. On 24, surpassing its pre-pandemic level by 13.6 per the other hand, weak external demand restrained cent (Chart III.1 and Table III.1). The momentum of domestic activity. On the supply side, the broad- GDP – quarter-on-quarter (q-o-q) seasonally adjusted based buoyancy of services activity was sustained annualised growth rate (saar) – exhibited the usual by the strong momentum driving contact-intensive seasonal decline in Q1:2023-24 in line with the post- services. Agriculture activity has withstood pandemic trends, albeit the pace of contraction was the vicissitudes of the south-west monsoon. less than a year ago. Manufacturing sector extended a modest recovery GDP Projections versus Actual Outcomes on the back of moderating input cost pressures and improving profit margins. The April 2023 Monetary Policy Report (MPR) had projected real GDP growth at 7.8 per cent for Chart III.1: GDP Growth and its Constituents b: GDP Growth and Momentum 30 24 18 12 6 0 -6 -12 -18 -24 -30 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 2020-21 2021-22 2022-23 2023-24 Note: saar – Seasonally adjusted annualised rate. Sources: National Statistical Office (NSO); and RBI staff estimates. 35 stniopegatnecreP a: Weighted Contribution of the Components to GDP Growth PFCE GFCE GFCF Net exports GDP(y-o-y, per cent)Monetary Policy Report October 2023 Table III.1: Real GDP Growth (y-o-y, per cent) Item 2021-22 2022-23 Weighted 2021-22 2022-23 2023-24 Contribution (FRE) (PE) 2021-22 2022-23 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Private final consumption expenditure 11.2 7.5 6.4 4.4 17.6 14.2 10.8 4.7 19.8 8.3 2.2 2.8 6.0 (5.4) (13.4) (-9.3) (5.9) (12.6) (11.8) (8.6) (14.7) (15.0) (14.9) (15.1) Government final consumption expenditure 6.6 0.1 0.7 0.0 -2.1 11.7 5.8 11.8 1.8 -4.1 -0.6 2.3 -0.7 (5.6) (5.7) (6.3) (-17.6) (0.9) (38.0) (8.3) (-20.9) (0.2) (41.1) (7.5) Gross fixed capital formation 14.6 11.4 4.6 3.7 61.0 12.4 1.2 4.9 20.4 9.6 8.0 8.9 8.0 (6.2) (18.3) (-9.6) (11.1) (4.3) (19.6) (8.8) (21.7) (12.6) (30.3) (17.5) Exports 29.3 13.6 5.5 3.0 46.1 25.1 27.8 22.4 19.6 12.2 11.1 11.9 -7.7 (17.5) (33.4) (8.8) (17.2) (16.8) (27.1) (30.1) (31.6) (29.8) (42.3) (20.1) Imports 21.8 17.1 4.6 4.0 44.8 26.6 19.7 6.7 33.6 23.1 10.7 4.9 10.1 (5.2) (23.2) (-14.6) (4.2) (13.6) (19.5) (14.1) (28.2) (25.7) (25.3) (25.6) GDP at market prices 9.1 7.2 9.1 7.2 21.6 9.1 5.2 4.0 13.1 6.2 4.5 6.1 7.8 (2.7) (10.1) (-6.9) (2.9) (6.9) (7.5) (5.3) (9.2) (11.6) (14.0) (13.6) Notes: Component-wise weighted contributions to growth do not add up to GDP growth because change in stocks, valuables and discrepancies are not included. Figures in parentheses are growth rates over 2019-20. FRE: First revised estimates; PE: Provisional estimates. Sources: NSO; and RBI staff estimates. Q1:2023-24. Actual growth turned out to be the same III.1.1 Private Final Consumption Expenditure as the projection (Chart III.2). Private final consumption expenditure (PFCE) – the mainstay of aggregate demand – rose by 6.0 per cent in Q1:2023-24 and contributed 3.5 percentage points Chart III.2: GDP Growth - Projection to overall GDP growth. Amongst the high frequency versus Actual - Q1:2023-24 indicators (HFIs) of urban consumption, domestic air passenger traffic and passenger vehicle sales recorded sustained growth in H1 (Chart III.3a and b); however, consumer durables were subdued during April-July, dragged down by textiles, readymade garments, and cut and polished diamonds (Chart III.3c). Bank credit to households remained supportive of urban consumption (Chart III.3d). Rural demand showed incipient signs of recovery in H1 (Chart III.4). Tractor sales recovered during May- August, exceeding pre-pandemic levels. Motorcycle sales also expanded in Q1 but dipped in July-August Sources: NSO; and RBI staff estimates. and trailed last year levels. Consumer non-durables 36Chapter III Demand and Output Chart III.3: Urban Demand: High-Frequency Indicators a: Domestic Air Passenger Traffic b: Passenger Vehicle Sales c: Consumer Durables d: Household Credit Sources: Directorate General of Civil Aviation (DGCA); Society of Indian Automobile Manufacturers (SIAM); NSO; and RBI. and sales volume of major fast-moving consumer recovered in July-August after a dip in Q1 with the goods (FMCGs) improved in H1. Fertiliser sales progress of kharif sowing. Chart III.4: Rural Demand: High-Frequency Indicators a: Tractor Sales b: Motorcycle Sales c: Consumer Non-durables d: Fertiliser Sales 60 40 20 Sources: Tractor Manufactures Association; SIAM; NSO; and Ministry of Chemicals and Fertilisers. 37 sennothkaL naJ beF raM rpA yaM nuJ luJ guA peS tcO voN ceD 300 250 200 150 100 70 50 30 2019 2022 2023 hkaL naJ beF raM rpA yaM nuJ luJ guA peS tcO voN ceD 2019 2022 2023 40 30 20 10 0 tnec repnihtworgy-o-y 22-rpA 22-nuJ 22-guA 22-tcO 22-ceD 32-beF 32-rpA 32-nuJ 32-guA Personalloans Vehicleloans CreditcardoutstandingMonetary Policy Report October 2023 Chart III.5: Employment Situation in India a: Unemployment and Labour Participation Rates b: Net Payroll Additions in EPFO Records 16 42 14 40 12 10 38 8 6 36 4 34 2 0 32 Sources: CMIE; and Employees’ Provident Fund Organisation (EPFO). The labour force participation rate1 inched up to iron and steel (Chart III.6a). Railway locomotives, 40.9 per cent in September 2023 from 39.8 per separators, bodies of trucks and buses supported the cent in March (Chart III.5a). The unemployment domestic production of capital goods (Chart III.6b). rate increased to 8.9 per cent in September from Coincident indicators of construction activity – steel 8.6 per cent in March in urban areas while in rural consumption and cement production – posted strong areas it moderated to 6.2 per cent from 7.8 per growth in H1, bolstered by both residential spending cent during this period. The Employees’ Provident and government’s infrastructure push (Chart III.6c Fund Organisation (EPFO) payrolls data point to and d). an improvement in employment conditions in the Capacity utilisation (CU) in the manufacturing sector2 organised sector during June-July (Chart III.5b). recorded a seasonal dip to 73.6 per cent in Q1:2023-24 III.1.2 Gross Fixed Capital Formation from 76.3 per cent in Q4:2022-23, close to the long- term average of 73.7 per cent3. Seasonally adjusted Gross fixed capital formation (GFCF) expanded capacity utilisation improved to 75.4 per cent from by 8.0 per cent in Q1:2023-24, driven up by the 74.1 per cent (Chart III.7). Stretched capacity utilisation government’s capex push and a modest uptick in in manufacturing presages the need for new capacity private sector investment. The share of GFCF in additions to keep pace with the strength of underlying GDP was 34.7 per cent in Q1, the same as a year ago. domestic demand in the economy. Amongst the key underlying indicators, imports of capital goods expanded during April-August, led by The interest coverage ratio (ICR)4 of listed non- machinery, electrical and non-electrical goods and financial private companies in the manufacturing and 1 Based on the Centre for Monitoring Indian Economy’s (CMIE) Consumer Pyramids data. 2 Based on RBI’s survey of order books, inventories and capacity utilisation. 3 Long term average is for the period Q1:2008-09 to Q1:2023-24 excluding Q1:2020-21. 4 The interest coverage ratio is the ratio of earnings before interest and taxes (EBIT) to interest expenses. 38 tnec reP 22-naJ 22-raM 22-yaM 22-luJ 22-peS 22-voN 32-naJ 32-raM 32-yaM 32-luJ 32-peS tnec reP Labour participationrate-AllIndia(RHS) Employmentrate-All India (RHS) Unemploymentrate-All India Unemploymentrate - Rural Unemploymentrate- UrbanChapter III Demand and Output Chart III.6: Indicators of Investment Demand a: Imports of Capital Goods b: IIP Capital Goods c: Finished Steel Consumption d: Cement Production Sources: Directorate General of Commercial Intelligence and Statistics (DGCI&S); NSO; Joint Plant Committee; and Office of Economic Adviser. information technology (IT) sectors persisted at high capacity. The ICR of non-IT services companies also levels in Q1, indicating comfortable debt servicing ruled above the threshold level of one (Chart III.8). Chart III.7: Capacity Utilisation in Chart III.8: Interest Coverage Ratio Manufacturing Note: Data for Q1:2023-24 are based on results of 1,712 listed private manufacturing companies and 760 listed private non-financial services companies. Source: RBI. Source: RBI staff estimates. 39Monetary Policy Report October 2023 Chart III.9: Centre’s Expenditure during April-August a: Expenditure Growth b: Quality of Expenditure Sources: Controller General of Accounts (CGA) and RBI staff estimates. III.1.3 Government Consumption Chart III.10). GST collections (centre plus states) drew buoyancy from improving economic activity and Government final consumption expenditure (GFCE) compliance. Custom duty receipts surged - despite a contracted by 0.7 per cent in Q1:2023-24, pulling contraction in merchandise exports and imports - on down GDP growth. The central government’s revenue account of, inter alia, higher export and import duties expenditure excluding interest payments and for a few items. Union excise duties inched down, subsidies grew by 13.1 per cent (y-o-y) during April- August 20235. The outgo on major subsidies surged by 32.5 per cent during April-August due to higher food Chart III.10: GST Collections (Centre plus States) and fertiliser subsidies. Capital expenditure expanded 200 by 48.1 per cent (y-o-y) during April-August, driven by 175 35.3 per cent increase in capital outlay, led by railways sector (Chart III.9a). The revenue expenditure to 150 capital outlay (RECO) ratio decreased to 4.1 in April- 125 August from 4.9 a year ago, indicative of the ongoing 100 qualitative improvement in central government expenditure (Chart III.9b). 75 On the receipts side, the central government’s gross 50 tax revenues increased by 16.5 per cent y-o-y during 25 April-August 2023, driven by a growth of 26.1 per cent in direct taxes. Indirect tax revenues expanded 0 Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar by 7.9 per cent y-o-y, aided by goods and services tax Source: Press Information Bureau (PIB). (GST) collections and custom duties (Table III.2 and 5 Growth was (-)7.3 per cent in Q1:2023-24 and 65.4 per cent in July-August 2023. The high July-August growth was partly due to base effect. 40 erorcdnasuoht(cid:31) 2021-22 2022-23 2023-24Chapter III Demand and Output Table III.2: Central Government’s Tax Collections Item ` thousand crore Per cent BE Actuals Per cent to BE Growth Rate 2022-23 2023-24 Apr-Aug 2022 Apr-Aug 2023 Apr-Aug 2022 Apr-Aug 2023 Apr-Aug 2022 Apr-Aug 2023 A. Direct taxes 1,420.0 1,823.3 483.2 609.4 34.0 33.4 28.3 26.1 Of which 1. Corporation tax 720.0 922.7 207.6 238.9 28.8 25.9 23.6 15.1 2. Income tax 680.0 873.0 265.6 360.4 39.1 41.3 33.2 35.7 B. Indirect taxes 1,337.8 1,537.6 537.4 579.7 40.2 37.7 11.3 7.9 Of which 1. Total GST 783.7 960.5 355.1 392.7 45.3 40.9 33.0 10.6 2. Custom duties 213.0 233.1 65.3 83.5 30.7 35.8 -14.3 27.8 3. Union excise duties 335.0 339.0 114.0 99.8 34.0 29.4 -17.0 -12.4 C. Gross tax revenue 2,757.8 3,360.9 1020.6 1189.2 37.0 35.4 18.7 16.5 D. Assignment to States/UTs 816.6 1,021.4 317.8 382.5 38.9 37.4 49.5 20.4 E. Net tax revenue 1,934.8 2,330.6 700.1 803.9 36.2 34.5 8.6 14.8 Note: BE: Budget Estimates. Sources: Union Budget Documents; and CGA. partly on account of the cut in excise duty on petrol central government’s gross fiscal deficit (GFD) stood and diesel in May 2022. Overall, net tax revenue of the at 36.0 per cent of the full year’s budget estimates central government increased by 14.8 per cent during (BE), higher than 32.6 per cent a year ago. April-August. Turning to state governments, their consolidated The central government’s non-tax revenues jumped GFD is budgeted at 3.1 per cent of the GDP in by 79.4 per cent during April-August 2023 due to 2023-24, i.e., within the 3.5 per cent limit stipulated by higher dividends and profits (Chart III.11). The the central government. Growth in revenue receipts is Reserve Bank of India’s dividend rose to `87,416 crore budgeted to accelerate, led by tax revenue (Table III.3 from `30,307 crore last year. During April-August, the and Chart III.12a). Capital spending is expected to rise by 40.3 per cent in 2023-24 on top of 18.5 per cent a Chart III.11: Non-tax Revenue - April-August year ago, boosted by the support of `1.3 lakh crore from the central government under the ‘Scheme for Special Assistance to States for Capital Investment’. The revenue expenditure to capital outlay ratio is budgeted to fall to 5.0 in 2023-24 from 6.1 in 2022-23. Table III. 3: State Government Finances – Key Deficit Indicators Item (Per cent of GDP) 2021-22 2022-23 2023-24 (A) (PA) (BE) Revenue deficit 0.4 0.3 0.1 Gross fiscal deficit 2.8 2.8 3.1 Primary deficit 1.0 1.2 1.4 Notes: A: Actuals; PA: Provisional Accounts; BE: Budget Estimates. Data pertains to 31 States and UTs. Sources: Budget Documents of State Governments; and Comptroller and Source: CGA. Auditor General (CAG) of India. 41Monetary Policy Report October 2023 Chart III.12: Trend in Key Indicators of the States/UTs a: Receipts and Expenditure of States and UT's b: Deficit Indicators of States: April-July Notes: 1. Data in panel a pertain to 31 states/UTs. 2. Data in panel b pertain to 23 states. Sources: Budget Documents of State Governments; and CAG. Amongst the key deficit indicators of the states/UTs, during H1 at 7.2 per cent was marginally lower than consolidated revenue deficit improved during April- 7.3 per cent a year ago, while the weighted average July 2023, while gross fiscal deficit deteriorated due maturity elongated to 17.6 years from 15.7 years. to front loading of capex during this period (Chart During H2, the Centre's gross market borrowings III.12b). Capital expenditure of the states increased through dated securities have been planned for `6.55 by 49.8 per cent y-o-y during April-July, aided by lakh crore. States raised gross market borrowings an additional instalment of tax devolution from of `3.58 lakh crore during H1 as against `4.37 lakh the central government and an approval of `84,884 crore in the indicative calendar. During Q3:2023-24, crores (as on July 25, 2023) from the centre under the indicative calendar has placed states gross market ‘Scheme for Special Assistance to States for Capital borrowings at `2.37 lakh crore. To meet the transitory Investment’. mismatches between receipts and expenditure, the Ways and Means Advances (WMA) limit for the The Union Budget 2023-24 provided for gross and net market borrowings through dated securities at `15.43 central government for H1 was `1.5 lakh crore, and lakh crore and `11.81 lakh crore, respectively. The it has been fixed at `50,000 crore for H2. For states/ centre’s gross issuances of market borrowings through union territories, the WMA limits remained at `47,010 dated securities amounted to `8.88 lakh crore during crore as recommended by the Advisory Committee H1 (57.6 per cent of the full year’s budgeted amount) on Ways and Means Advances to State Governments (Table III.4). The weighted average cost of issuances (Chairman: Shri Sudhir Shrivastava). Table III.4: Government Market Borrowings (` crore) 2021-22 2022-23 2023-24 (April to September) Centre States Total Centre States Total Centre States Total Net borrowings 8,63,103 4,92,483 13,55,586 11,08,261 5,18,830 16,27,091 7,29,236 2,32,564 9,61,800 Gross borrowings 11,27,382 7,01,626 18,29,008 14,21,000 7,58,392 21,79,392 8,88,000 3,58,022 12,46,022 Sources: Government of India; and RBI staff estimates. 42Chapter III Demand and Output III.1.4 External Demand Chart III.13: Merchandise Trade India’s external demand was weighed down by the 60 15 slowing global economy, persisting geopolitical 10 tensions, and geoeconomic fragmentation. 40 5 Merchandise exports and imports (US$ terms) have 20 0 been in contraction territory since February 2023. -5 Services trade exhibited slowdown during April-August 0 -10 amidst global headwinds. According to the NSO, -20 -15 exports of goods and services contracted by 7.7 per cent -20 in real terms, while imports of goods and services grew -40 -25 by 10.1 per cent, resulting in a sharp jump in the drag -60 -30 from net exports to (-) 6.4 per cent of GDP in Q1:2023- 24 from (-) 0.1 per cent in Q4:2022-23 and (-) 2.3 per cent a year ago. Merchandise exports (US$ terms) fell by 11.9 per Source: DGCI&S. cent y-o-y during April-August 2023, and merchandise imports by 12.1 per cent. The merchandise trade decline on y-o-y basis, led by petroleum products, deficit moderated to US$ 98.9 billion in April-August gems and jewellery and engineering goods. On the 2023 from US$ 112.9 billion a year ago as the decline in imports outpaced that in exports (Chart III.13). other hand, electronic goods, iron ore and drugs and pharmaceuticals, accounting for 13.5 per cent of Merchandise exports experienced a broad-based total merchandise exports6, contributed positively to downturn across commodities. During April-August 2023, 18 out of 30 major commodities (with a share export growth (Chart III.14). Overall, non-oil exports of 73.9 per cent in the export basket) registered a fell by 7.5 per cent during this period. 43 tnecrep nihtworg y-o-y 22-rpA 22-yaM 22-nuJ 22-luJ 22-guA 22-peS 22-tcO 22-voN 22-ceD 32-naJ 32-beF 32-raM 32-rpA 32-yaM 32-nuJ 32-luJ 32-guA noillib $SU Trade balance (RHS) Exports Imports Non-oil exports Non-oil non-gold imports Chart III.14: Exports Growth a: Exports Growth-Relative Contribution b: Major Drivers of Exports in April-August 2023 Notes: 1) Q2*: July-August 2023. World trade data is for July 2023. 2) The Chart b lists top 5 and bottom 5 commodities by relative contribution, sorted by y-o-y change during April-August 2023. Sources: DGCI&S; CPB, Netherlands; and RBI staff estimates. 6 The share is based on April-August 2023.Monetary Policy Report October 2023 Chart III.15: Imports Growth a: Imports Growth-Relative Contribution b: Major Drivers of Imports in April-August 2023 Notes: 1) Q2*: July-August 2023. 2) The chart b lists top 5 and bottom 5 commodities by relative contribution, sorted by y-o-y change during April-August 2023. Sources: DGCI&S; and RBI staff estimates. Chart III.16: Services Trade 50 40 30 20 10 0 -10 -20 Q1Q2Q3Q4Q1Q2Q3Q4Q1Q2Q3Q4Q1Q2Q3Q4Q1 2019-20 2020-21 2021-22 2022-23 2023-24 Note: Data for Q1:2023-24 and Q2:2023-24 are provisional. Q2*: July-August 2023. Source: RBI. 44 tnecrep nihtworg y-o-y In the case of imports, 17 major commodities, account, net FDI inflows moderated to US$ 5.8 billion accounting for 55.4 per cent of the imports basket, during April-July 2023 amidst a broader fall in global registered contraction during April-August 2023, FDI flows (Chart III.17). Manufacturing, financial driven by petroleum and crude products, coal and services, business services, and computer services chemicals. Electronic goods, machinery, electrical were the major recipient sectors while Singapore, and non-electrical products and gold imports, on the Japan, the Netherlands, the USA and Mauritius were other hand, expanded (Chart III.15). Non-oil non-gold the major source countries of inward FDI to India. imports fell by 9.0 per cent. Services exports were buoyed by software services, business and financial services and travel services in Q1:2023-24. Services exports growth moderated substantially to 6.8 per cent during April-August 2023 from 32.1 per cent a year ago, partly reflecting slowdown in key partner countries (Chart III.16). Services imports posted a muted growth of 0.9 per cent in Q1:2023-24, with decline in outgoes under transportation servces. Services imports declined by 1.5 per cent y-o-y in July-August 2023. On a balance of payments basis, the current account deficit narrowed to 1.1 per cent of GDP in Q1:2023-24 Q2* from 2.1 per cent of GDP in the corresponding period Exports Imports of the previous year on the back of lower merchandise trade deficit, higher net surplus in services exports and robust inward remittances. In the financialChapter III Demand and Output in H1:2023-24 as against an outflow of US$ 8.1 billion Chart III.17: Net Foreign Direct and during the same period last year. External commercial Portfolio Investment borrowing (ECB) flows also exhibited a turnaround, 20 with net inflows at US$ 4.5 billion in 2023-24 (up 15 to August) in comparison with net outflows of US$ 10 3.2 billion in the same period of last year, driven by 5 higher disbursements. Net accretions to non-resident 0 deposits inched up to US$ 3.0 billion during April- -5 July 2023 from US$ 1.4 billion a year ago, mainly due -10 to higher flows in Foreign Currency Non-Resident -15 (FCNR-B) deposits. As on September 29, 2023, India’s -20 foreign exchange reserves amounted to US$ 586.9 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2* billion, equivalent to 10.1 months of projected 2021-22 2022-23 2023-24 merchandise imports in 2023-24 and 93.9 per cent of Notes: Data for Q1:2023-24 and Q2:2023-24 are provisional. outstanding external debt at end-June 2023. *: Net FDI data is for July 2023. Sources: National Securities Depository Limited (NSDL); and RBI. III.2 Aggregate Supply Foreign portfolio investment (FPI) rebounded mainly Aggregate supply – measured by real gross value through the equity route in response to investors’ added (GVA) at basic prices – expanded by 7.8 positive outlook on domestic growth and corporate per cent in Q1:2023-24 (11.9 per cent a year earnings. FPI inflows of US$ 20.5 billion were recorded ago), led by services sector activity (Table III.5). 45 noillib $SU Net FDI Net FPI Table III.5: Real GVA Growth (y-o-y, per cent) Item 2021-22 2022-23 Weighted 2021-22 2022-23 2023-24 Contribution (FRE) (PE) 2021-22 2022-23 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Agriculture, forestry and fishing 3.5 4.0 3.4 4.8 2.3 4.1 2.4 2.5 4.7 5.5 3.5 0.6 0.6 (7.8) (12.0) (7.4) (9.4) (7.2) (7.6) (10.0) (12.1) (12.3) (13.5) (13.8) 10.5 2.4 42.1 7.3 2.2 1.3 7.3 -2.5 0.1 4.7 4.6 Industry 2.4 0.6 (11.5) (14.2) (3.9) (13.8) (11.9) (16.4) (11.5) (10.9) (12.0) (21.9) (16.7) 7.1 4.6 12.2 10.6 5.4 2.3 9.5 -0.1 4.1 4.3 5.8 Mining and quarrying 0.2 0.1 (-2.1) (2.4) (-7.5) (1.7) (-0.3) (-1.5) (1.3) (1.6) (3.8) 2.7) (7.1) 11.1 1.3 51.5 6.6 1.3 0.6 6.1 -3.8 -1.4 4.5 4.7 Manufacturing 2.0 0.3 (14.3) (15.8) (6.3) (16.2) (14.3) (20.2) (12.8) (11.7) (12.7) (25.6) (18.1) Electricity, gas, water supply and 9.9 9.0 16.3 10.8 6.0 6.7 14.9 6.0 8.2 6.9 2.9 0.2 0.2 other utilities (5.1) (14.5) (-1.6) (6.4) (6.7) (9.4) (13.1) (12.8) (15.5) (16.9) (16.3) 9.6 9.5 17.9 11.0 6.5 4.9 16.3 8.9 6.4 7.4 10.0 Services 5.8 5.8 (0.9) (10.5) (-10.8) (-0.5) (6.3) (9.1) (3.7) (8.4) (13.2) (17.2) (14.1) 14.8 10.0 77.0 10.8 0.2 4.9 16.0 5.7 8.3 10.4 7.9 Construction 1.1 0.8 (8.2) (19.1) (-8.7) (5.3) (8.6) (26.0) (6.0) (11.3) (17.7) (39.1) (14.3) 13.8 14.0 41.4 13.1 9.2 5.0 25.7 15.6 9.6 9.1 9.2 Trade, hotels, transport, communication 2.3 2.5 (-8.7) (4.1) (-28.6) (-7.7) (-1.2) (1.8) (-10.2) (6.7) (8.3) (11.0) (-2.0) Financial, real estate and professional 4.7 7.1 2.8 7.0 4.3 4.6 8.5 7.1 5.7 7.1 12.2 1.1 1.6 services (6.9) (14.6) (1.9) (1.6) (14.4) (13.2) (10.6) (8.8) (20.9) (21.3) (24.1) Public administration, defence and 9.7 7.2 6.5 16.8 10.6 5.2 21.3 5.6 2.0 3.1 7.9 1.2 0.9 other services (1.3) (8.6) (-7.9) (2.5) (5.1) (4.5) (11.6) (8.2) (7.2) (7.8) (20.5) 8.8 7.0 20.2 9.3 4.7 3.9 11.9 5.4 4.7 6.5 7.8 GVA at basic prices 8.8 7.0 (4.2) (11.5) (-5.1) (3.7) (7.7) (10.5) (6.3) (9.3) (12.7) (17.6) (14.6) Notes: FRE: First revised estimates; PE: Provisional estimates. Figures in parentheses are growth rates over 2019-20. Sources: NSO; and RBI staff estimates.Monetary Policy Report October 2023 Moderating global energy and non-energy prices asymmetric impact on activity: the positive impact supported value addition in both manufacturing and of easing prices is lower than the negative impact services sectors. Petroleum product prices have an of an equivalent increase in prices (Box III.1). Box III.1: Asymmetric Impact of Energy Prices on Economic Activity Global energy prices have a sizeable impact on output overall GVA growth by around 33-36 bps and 24-39 bps, and prices in countries heavily dependent on imports respectively, whereas an equivalent reduction of one of energy. The impact of oil and other energy prices per cent in diesel prices boosts manufacturing GVA and increases/decreases on output can be asymmetric (Rahman overall GVA growth by a lower magnitude of around 7-8 and Serlitis, 2010; Catik and Onder, 2013). Against this bps and 4-9 bps, respectively (Table III.1.1). In the linear backdrop, the potential asymmetric impact of oil prices model, a one per cent increase/decrease in oil prices on aggregate gross value added (GVA) and manufacturing GVA is assessed by using a non-linear autoregressive Table III.1.1: Oil prices and GVA: Linear and distributed lag (NARDL) modelling framework over the Non-Linear ARDL Model Estimates period Q1:2005-06 to Q1:2023-24. A linear model is also Panel A: Long Run Estimates estimated for comparative analysis. The model includes Overall GVA GVA: Manufacturing the real weighted average lending rate (IR), the global Linear Non- Linear Non- Linear Non- Linear Non- index of industrial production (GIIP) as a control for Linear Linear Linear Linear global economic activity and wholesale price index (WPI) Model 1 Model 2 Model 1 Model 2 of diesel (OIL) (as a measure of domestic oil price). All Selected (4,3,2) (3,2,0) (4,3,2,2)(3,3,4,4) (4,1,3) (4,1,0)(4,1,1,3)(3,0,4,1) ARDL variables, except the interest rate, are in log form in the Model long-run equation and in first differences in the short-run IR -0.017 -0.004 -0.041 -0.076 -0.004 -0.004 -0.015 -0.040 (0.54) (0.57) (0.41) (0.04) (0.84) (0.72) (0.55) (0.02) equation. Two models are estimated: (i) excluding GIIP GIIP 0.29 0.87 -.003 1.11 (Model 1) and (ii) including GIIP (Model 2). The NARDL (0.62) (0.05) (0.45) (0.01) model takes the following form: OIL -0.19 -0.23 -0.14 -0.14 (0.03) (0.08) (0.00) (0.00) OIL+ -0.24 -0.39 -0.33 -0.36 (0.00) (0.00) (0.00) (0.00) OIL– -0.04 -0.09 -0.08 -0.07 (0.08) (0.07) (0.00) (0.08) ECM -0.09 -0.28 -0.06 -0.14 -0.39 -0.52 -0.25 -0.32 (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) BPG test: 0.54 0.62 0.38 0.81 0.96 0.99 0.91 0.58 p-value LM test: 0.92 0.25 0.32 0.47 0.34 0.20 0.86 0.35 p-value Panel B: Coefficient Symmetry Tests (F-statistic) where Y is the dependent variable (Aggregate GVA or (H0: Coefficients are symmetric) Manufacturing GVA) and X are the explanatory variables Overall GVA GVA: Manufacturing (IR, GIIP, Oil+, Oil-). The bound tests confirms the presence Model 1 Model 2 Model 1 Model 2 Long -run 33.1 10.7 31.5 11.1 of a long run cointegrating relationship. The model (0.00) (0.00) (0.00) (0.00) diagnostics are satisfactory and the coefficient of the error Short run - 23.7 - 0.01 correction term in the short-run equations is negative, (0.00) (0.93) Joint (Long and short-run) - 15.4 - 5.9 less than 1 and statistically significant. (0.00) (0.00) Note: Figures in parentheses are p-values. The results indicate that an increase of one per cent in Source: RBI staff estimates. domestic diesel prices reduces manufacturing GVA and (Contd.) 46Chapter III Demand and Output reduces/increases manufacturing GVA and overall GVA by References: a relatively modest 14 bps and 19 bps, respectively. The Çatık, A and Önder, A. (2013), “An Asymmetric Analysis asymmetric impact could reflect incomplete pass-through of the Relationship between Oil Prices and Output: The by firms of higher input costs during the upswing phase case of Turkey”, Economic Modelling, Vol. 33, pp. 884-892. of oil prices and the lower downward rigidity in output prices when oil prices correct. With oil prices remaining Rahman, S. and Serletis, A. (2010), “The Asymmetric highly volatile, the adverse impact of any positive oil price Effects of Oil Price and Monetary Policy Shocks: A Non- shock is thus not fully offset by a similar degree of price linear VAR approach”, Energy Economics, Vol. 32(6), pp. correction. 1460-1466, November. The momentum of GVA was negative in Q1, reflecting the month at 36 per cent touched a new record. The the post-pandemic pattern (Chart III.18). monsoon, however, recovered in September, which helped to narrow the cumulative rainfall deficit to III.2.1 Agriculture 6 per cent below the long period average (LPA) (6 Real GVA in agriculture, forestry and fishing posted a per cent above LPA a year ago), with 29 out of the growth of 3.5 per cent in Q1:2023-24 (2.4 per cent a 36 sub-divisions receiving normal or above normal year ago). The south-west monsoon (June-September rainfall (Chart III.19a and b). The area under kharif 2023) remained uneven in terms of spatial and sowing during 2023-24 swas marginally higher than temporal rainfall distribution. After a sluggish start last year. Amongst the major crops, area under rice in June, the monsoon gained strength in July but was 1.9 per cent higher while acreage under pulses lost momentum in August and rainfall deficiency for and oilseeds was lower by 4.2 per cent and 1.6 per cent, respectively (Chart III.19c). As of September 29, Chart III.18: GVA Growth and Momentum 2023, the reservoir levels stood at 73 per cent of the 25 110 full capacity — below the last year’s level of 89 per 20 cent and the decadal average of 79 per cent (Chart 90 15 III.19d). The production weighted rainfall (PRN) 10 70 index was 93 as on September 30, 2023. The PRN 5 50 0 for major crops was below normal except for cotton, 30 -5 pulses and oilseeds (Chart III.19e and f). 10 -10 -10 The government announced an increase of 5.3-10.4 -15 -30 per cent in minimum support prices (MSP) for kharif -20 crops, ensuring a return of at least 50 per cent over -25 -50 the cost of production (as measured by A2 plus FL7). -30 -70 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 The procurement of rice during the kharif marketing 2020-21 2021-22 2022-23 2023-24 season 2022-23 ended at 570 lakh tonnes was 3.9 per Sources: NSO; and RBI staff estimates. cent lower than in the previous year. For wheat, on the 47 tnec reP tnec reP y-o-y growth q-o-q saar (RHS) 7 A2 (out of pocket expenses) plus FL (family labour) includes all paid out costs such as expenses on hired labour, machines, rent paid for leased land, seeds, fertilisers, irrigation charges, depreciation as well as imputed value of family labour.Monetary Policy Report October 2023 c: Kharif Sowing Progress d: Reservoir Level (September 29, 2023) 1200 1000 800 600 400 200 0 end-Jun end-Jul end-Aug end-Sep e: Production-weighted Rainfall Index (PRN) f: PRN Crop-wise (June 1 - September 30) (June 1 - September 30) Note:*Normal area as on date is the average of 5 years - 2018-19 to 2022-23. Sources: India Meteorological Department (IMD); Central Water Commission; Ministry of Agriculture and Farmers' Welfare; and RBI staff estimates. 48 seratcehhkaL 120 100 80 60 40 20 0 NormalArea* 2021 2022 2023 yticapacfotnec reP Chart III.19: Progress of Rainfall and Kharif Sowing a: Cumulative Weekly Progress of South-west b: Comparative Rainfall Position Monsoon Rainfall Northern Eastern Western Central Southern All-India Averageoflast10years 2022 2023 Rice 140 120 Cotton 100 CoarseCereals 80 60 Sugarcane Pulses Oilseeds Average(2018-2022) 2022 2023 other hand, the procurement at 262 lakh tonnes as on and wheat at 326.4 lakh tonnes and 252.2 lakh tonnes, September 27, 2023 was 39.4 per cent higher than last respectively, were 2.4 times and 0.9 times respective year. As on September 16, 2023, buffer stocks of rice buffer norms (Chart III.20a and b).Chapter III Demand and Output Chart III.20: Stock, Procurement and Offtake Position – Rice and Wheat a: Rice b: Wheat Note: Rice and wheat stock for September 2023 is as on September 16. Source: Food Corporation of India. III.2.2 Industry The index of industrial production (IIP) posted a growth of 4.8 per cent y-o-y during April- Industrial GVA expanded by 4.6 per cent in Q1:2023- July 2023 (9.2 per cent above the pre-pandemic 24 (7.3 per cent a year ago), driven by stronger level), supported by all its constituents – mining, manufacturing activity than a year ago, benefitting manufacturing and electricity (Chart III.22 and from easing input cost pressures and normalisation of Table III.6). Pharmaceuticals, basic metals, non- supply chains (Chart III.21). Chart III.21: Industrial GVA Growth a: Weighted Contribution to Industrial GVA Growth b: Manufacturing Sector Profitability Note: Data for Q1:2023-24 are based on results of 1712 listed private manufacturing companies. Source: NSO; and RBI staff estimates. Source: RBI staff estimates. 49Monetary Policy Report October 2023 Chart III.22: Index of Industrial Production (IIP) a: Sectoral Contribution to IIP Growth (y-o-y) b: Use-based Contribution to IIP Growth (y-o-y) Sources: NSO; and RBI staff estimates. metallic mineral products, electrical equipment Electricity, gas, water supply and other utility and motor vehicles were the main drivers of services registered moderate growth, owing to manufacturing activity. In terms of the use-based lower household demand for electricity due to the classification, the production of infrastructure and relatively colder weather conditions during Q1. construction goods posted double digit growth, while Electricity generation rose by 5.3 per cent y-o-y in that of consumer durables contracted. April-August 2023 (10.6 per cent a year ago). Thermal Table III.6: Industrial Sector y-o-y growth (per cent) Indicators 2022-23 2023-24 Q1 Q2 Q3 Q4 Q1 Jul Aug Sep 1 PMI: Manufacturing (>50 indicates growth over previous month) 54.4 55.9 56.3 55.7 57.9 57.7 58.6 57.5 2 Index of Industrial Production (IIP) 12.8 1.6 2.8 4.5 4.6 5.7 3 IIP: Manufacturing 12.8 1.5 1.4 3.9 4.8 4.6 4 IIP: Primary goods 13.9 4.5 5.2 6.6 3.6 7.6 5 IIP: Capital goods 29.6 6.9 8.2 10.5 4.8 4.6 6 IIP: Infrastructure & construction goods 10.3 5.3 8.8 9.1 12.5 11.4 7 IIP: Consumer durables 27.2 -2.7 -8.9 -6.8 -2.7 -2.7 8 IIP: Consumer non-durables 1.2 -5.9 1.8 5.5 6.6 7.4 9 Eight Core Industries (ECI) 13.9 5.7 4.9 7.0 6.0 8.4 12.1 10 ECI: Steel 6.9 7.0 9.9 12.9 16.3 14.2 10.9 11 ECI: Cement 17.2 4.9 10.1 3.7 12.7 6.9 18.9 12 Electricity demand 18.5 5.8 7.3 6.9 1.5 12.1 16.0 Production of Automobiles 13 Passenger vehicles 32.7 38.1 21.4 13.0 7.0 9.5 11.9 14 Two wheelers 38.6 7.7 0.5 -3.0 1.3 -9.2 3.0 15 Three wheelers 5.9 24.3 13.3 7.0 24.3 25.0 17.0 16 Tractors 14.4 -1.6 6.2 34.7 -8.9 -12.1 -4.7 Sources: CMIE; CEIC; NSO; SIAM; and RBI staff estimates. 50Chapter III Demand and Output Chart III.23: Electricity Generation and Consumption a: Electricity Generation and Demand Growth b: Electricity Consumption: Region-wise 180000 20 160000 140000 15 nit) 120000 u ga100000 10 e ation(M 68 00 00 00 00 5 Percent er Gen 40000 0 20000 0 -5 Aug-22 Sep-22 Oct-22 Nov-22 Dec-22 Jan-23 Feb-23 Mar-23 Apr-23 May-23 Jun-23 Jul-23 Aug-23 Renewables Hydro Thermal Demandgrowthy-o-y(RHS) Sources: Central Electricity Authority; and Power System Operation Corporation Limited (POSOCO). and renewable sources recorded an increase of 6.3 The manufacturing purchasing managers index per cent and 14.5 per cent, respectively, during April- (PMI) indicated improvement in overall business August 2023 (Chart III.23a). Region-wise, electricity conditions. It rose to 57.9 in H1:2023-24 from 55.7 demand remained strong in all regions except in Q4:2022-23, with pick up in domestic and export in the northern region. Demand in the northern orders. The future output index also strengthened region picked up in July-August (Chart III.23b). (Chart III.24a). Chart III.24: PMI Manufacturing and Services a: PMI Manufacturing b: PMI Services 70 60 50 40 30 20 10 0 Note: >50: Expansion, < 50: Contraction. Source: S&P Global. 51 22-naJ 22-raM 22-yaM 22-luJ 22-peS 22-voN 32-naJ 32-raM 32-yaM 32-luJ 32-peS PMI manufacturing Neworders Newexportorders Nochange FutureoutputMonetary Policy Report October 2023 III.2.3 Services diesel and toll collections point to a healthy growth in road transport in H1. Railway freight traffic and port Services sector GVA recorded a robust growth of cargo, after a muted growth of 1.1 per cent and 1.7 per 10.0 per cent y-o-y in Q1:2023-24, exceeding the cent, respectively, in Q1 made a smart recovery in Q2 pre-pandemic level by 14.1.per cent. It was buoyed especially in August. by sustained growth in contact-intensive services, financial services, real estate activities and revival Real GVA growth in financial, real estate and in construction activity (Chart III.25a). Trade, hotels, professional services accelerated to 12.2 per cent transport, communication, and other services trailed in Q1:2023-24 from 8.5 per cent a year ago. Bank the pre-pandemic level by 2.0 per cent. Residential credit and deposits expanded by 15.3 per cent (y-o-y) housing demand and infrastructure spending by the and 12.3 per cent as on September 22, suggesting government propelled a strengthening of construction continued buoyancy in financial services. In the real activity. estate sector, new launches and sales increased by The traction in trade and transportation services 10.9 per cent and 8.4 per cent respectively on a y-o-y continued in Q2, as reflected in high frequency basis during Q1 and surpassed their pre-pandemic indicators. GST collections and issuances of e-way bills levels (Chart III.26a). According to the RBI’s all-India – indicators of wholesale and retail trade – remained housing price index, housing prices increased by solid. Cement production and steel consumption 5.1 per cent y-o-y in Q1, the highest in 19 quarters, reflected the improvement in construction activity led by Bengaluru, Delhi and Mumbai (Chart III.26b). (Chart III.25b). Domestic air passenger traffic Public administration, defence and other services expanded by 19.1 per cent in Q1 and by 24-26 per (PADO) posted a robust growth of 7.9 per cent y-o-y cent in July-August on the back of increased travel and in Q1 (21.3 per cent in Q1 of last year) primarily due business-related activities (Table III.7). High-speed to healthy growth in services like education, health, Chart III.25: Services Sector b: Construction Indicators 80 60 40 20 0 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 2021-22 2021-22 2022-23 Sources: NSO; Office of Economic Adviser; and Joint Plant Committee. 52 tnecrepnihtworgy-o-y a: Service Sector Components Construction Trade,hotels,transport, communication and services related tobroadcasting Financial,real estate & professional services Public administration, defence and other servicesChapter III Demand and Output Table III.7: Services Sector y-o-y growth (per cent) Indicators 2022-23 2023-24 Q1 Q2 Q3 Q4 Q1 Jul Aug Sep 1 PMI: Services (>50 indicates growth over previous month) 58.7 55.7 56.6 58.1 60.6 62.3 60.1 61.0 Construction 2 Steel consumption 10.1 13.0 12.7 17.1 10.4 17.6 21.5 3 Cement production 17.2 4.9 10.1 3.7 12.7 6.9 18.9 Trade, Hotels, Transport, Communication and Services related to Broadcasting 4 Commercial vehicle sales 112.2 39.5 16.6 11.6 -3.3 5 Domestic air passenger traffic 206.2 64.1 18.5 52.2 19.1 26.3 23.6 6 Domestic air cargo 32.1 10.0 -3.0 2.3 -1.0 -4.1 6.0 7 International air cargo -1.7 -3.8 -11.0 -2.8 0.1 1.0 7.4 8 Railway freight traffic 11.8 8.4 3.2 3.7 1.1 1.5 6.4 6.7 9 Port cargo 9.3 12.7 5.4 8.2 1.7 4.3 4.4 10 Toll collection: volume 88.9 35.6 30.8 20.2 15.4 11.3 13.3 15.4 11 Petroleum consumption 18.8 10.5 7.6 6.6 6.4 2.1 6.5 12 GST E-way bill 45.6 20.1 17.2 18.1 15.8 16.4 19.5 9.5 13 GST revenue 34.5 27.5 14.2 11.9 11.6 10.8 10.8 10.2 Financial, Real Estate and Professional Services 14 Credit outstanding 13.2 16.4 14.9 15.0 16.2 14.7 14.9 15.3 15 Bank deposits 8.3 9.2 9.2 9.6 12.9 12.0 12.3 12.3 16 Life insurance premium 39.7 36.6 19.1 -7.0 -0.9 -28.7 -18.5 17 Non-life insurance premium 23.5 10.0 17.1 16.7 18.0 13.8 -3.7 Sources: CMIE; CEIC; NSO; MOSPI; IRDAI; and RBI staff estimates. recreation and cultural services, which offset the driven by demand and new business gains muted growth in government consumption. (Chart III.24b). The Composite PMI index inched up The services PMI strengthened to 60.6 in from 58.3 in Q4:2022-23 to 60.9 in Q1:2023-24 and Q1:2023-24 and 61.1 in Q2 from 58.1 in Q4:2022-23, further to 61.3 in Q2. Chart III.26: Housing Sector – Launches, Sales and Prices a: Housing Activity b: Housing Price Index Sources: PropTiger; and RBI. 53Monetary Policy Report October 2023 III.3 Conclusion and business optimism, government’s continued thrust on capex, healthy balance sheets of banks and Domestic economic activity held up well in H1:2023- corporates, and supply chain normalisation should 24, despite an accentuated drag from weak external support economic activity. Geopolitical tensions demand. Private consumption improved across urban, and geoeconomic fragmentation, volatility in global and rural constituents. Investment activity drew financial markets and energy prices, global economic strength mainly from government capex. Looking slowdown and El Niño conditions pose risks to the ahead, the sustained buoyancy in services, consumer domestic outlook. 54IV. Financial Markets and Liquidity Conditions Domestic financial markets exhibited orderly movements and were range-bound during H1:2023-24. Bank lending and deposit rates increased, but the pass-through of the past rate hikes is still incomplete. Bank credit growth remained strong. Going forward, the Reserve Bank will conduct market operations to ensure financial stability while providing liquidity to meet the productive requirements of the economy. Introduction IV.1 Domestic Financial Markets Domestic financial markets exhibited orderly During H1:2023-24, global financial markets were movements. Money market rates were largely range volatile, reflecting heightened uncertainty around bound while government bond yields eased from the trajectory of monetary policy. Sovereign bond end-March 2023. The risk premium on corporate yields firmed up with core inflation remaining sticky, bonds moderated, equity market exhibited buoyancy tight labour markets and disinflationary resolve and the INR underwent two-way movements. The in monetary policy stances. Global equity markets transmission of cumulative policy rate changes led to gained during April-July 2023 on optimism about an a sustained firming up of bank deposit and lending early end to the tightening cycle, but they corrected rates. Growth in bank credit was robust, outpacing subsequently on expectations of policy rates staying deposit expansion. higher for longer. The US dollar remained volatile as IV.1.1 Money Market it fell to a 15-month low in mid-July but recouped its losses subsequently. Swings in capital flows and During H1:2023-24, money market rates oscillated tight global financial conditions posed challenges to within the policy corridor in tune with evolving macroeconomic and financial stability in emerging liquidity conditions and market operations of the market economies (EMEs). Reserve Bank (Chart IV.1a). On an average basis, Chart IV.1: Policy Corridor and WACR a: Liquidity, Policy Corridor and WACR b: Average Spread (WACR over Repo Rate) Source: Reserve Bank of India (RBI) and RBI staff calculations. 55Monetary Policy Report October 2023 the weighted average call money rate (WACR), the the share of reported deals in the total call money operating target of monetary policy, was 5 bps above market volume declined sharply from 33 per cent in the repo rate (Chart IV.1b). September 2022 to less than 1 per cent in September 2023. Other overnight money market rates viz., triparty repo (TREPS) and market repo moved in tandem with the Money market activity remained dominated by WACR, which intermittently firmed up above the MSF the collateralised segments, with the share of the rate – the ceiling of the LAF corridor – in August and uncollateralised call money market unchanged at September due to frictional liquidity tightness caused 2.0 per cent in H1. The share of TREPS moderated by advance tax payments, goods and services tax (GST) to 64 per cent in H1 from 70 per cent in H2:2022-23, outflows and the incremental CRR (I-CRR) prescribed with a corresponding increase in the share of market for all scheduled banks in August 2023. repo to 34 per cent from 27 per cent (Chart IV.3). Among investors, mutual funds (MFs) remained the In the overnight call money segment, the weighted major lenders in the triparty repo segment (64 per average rate (WAR) of traded deals1 was 5 bps above cent share in H1 as compared with 67 per cent in the policy repo rate (on an average basis) while that H2:2022-23) as well as in the market repo segment of reported deals was 13 bps below during H1:2023- (unchanged at 40 per cent). On the borrowing side, 24 (Chart IV.2a). The average monthly volume of the share of public sector banks (PSBs) in TREPS and traded deals (`2.1 lakh crore) dominated the reported market repo declined to 50 per cent and 7 per cent, segment (`0.1 lakh crore) due to the Reserve Bank’s respectively, in H1 from 61 per cent and 15 per cent, directive to all eligible participants (including respectively, in H2:2022-23. cooperative banks) to obtain NDS-CALL membership as well as the restoration of regular market hours in Among money market instruments, the yield on the call money market (Chart IV.2b). Consequently, 3-month T-bills (TBs) was broadly aligned with the Chart IV.2: Traded and Reported Deals in the Call Money Market – Volume and Rate a: Rate b: Monthly Volume Source: Clearing Corporation of India Ltd. (CCIL); RBI. 1 ‘Traded deals’ are negotiated directly on the NDS-Call platform whereas ‘reported deals’ are over-the-counter (OTC) deals which are reported on the NDS-Call platform after the completion of negotiation of deals. 56Chapter IV Financial Markets and Liquidity Conditions Chart IV.3: Share in Overnight Chart IV.4: Money Market Rates and Money Market Volumes Policy Corridor 8.5 8.0 7.5 7.0 6.5 6.0 5.5 5.0 Sources: CCIL; RBI. Sources: Financial Benchmarks India Pvt Ltd. (FBIL) and RBI. MSF rate in H1 while that on commercial paper (CP) crore in H2:2022-23 as deposit growth accelerated. and certificates of deposit (CDs) ruled above the MSF Resource mobilisation through fresh issuances of CPs rate (Chart IV.4). The spreads of TBs, CDs and CPs increased to `7.1 lakh crore during H1 from `6.4 over the policy repo rate narrowed to 27 bps, 50 bps lakh crore in H2:2022-23 (Chart IV.5a). The weighted and 66 bps, respectively, in H1:2023-24 from 30 bps, average discount rate (WADR) of CP issuances declined 85 bps and 99 bps, respectively, in H2:2022-23. to 7.15 per cent in H1:2023-24 from 7.21 per cent in Fresh issuances of CDs moderated to `3.0 lakh H2:2022-23. Corporates remained the major issuers of crore in H1 (up to September 22) from `3.8 lakh CPs with a share of 39 per cent in H1 (Chart IV.5b). 57 tnec reP 22-tcO-10 22-tcO-32 22-voN-41 22-ceD-60 22-ceD-82 32-naJ-91 32-beF-01 32-raM-40 32-raM-62 32-rpA-71 32-yaM-90 32-yaM-13 32-nuJ-22 32-luJ-41 32-guA-50 32-guA-72 32-peS-81 32-peS-92 WACR Tripartyrepo rate Marketreporate 3-month CPrate 3-monthCD rate 91-day T-bill rate SDF rate Reporate MSF rate Chart IV.5: Primary Issuances of Commercial Paper a: Systemic Liquidity, Issuances and WADR b: Institutional Break-up Source: RBI; CCIL-F-TRAC; and RBI staff estimates.Monetary Policy Report October 2023 the MPC’s decision to pause, lower than expected Table IV.1: Maturity Profile of CP Issuances domestic CPI inflation for March-April and softening (₹ lakh crore) US yields. In June, yields hardened taking cues from Tenor H1: H2: H1: 2022-23 2022-23 2023-24 rise in US yields. Overall, the 10-year benchmark 7- 30 days 0.69 0.38 0.45 yield fell by 21 bps in Q1 to close at 7.10 per cent. In 31-90 days 4.00 3.13 3.18 Q2, yields firmed up in July on the back of hardening 91-180 days 1.87 1.94 2.75 181-365 days 0.75 0.97 0.70 US yields and crude oil prices but remained steady Total 7.32 6.42 7.09 thereafter in August and September. On balance, Outstanding (as at end-period) 4.01 3.54 4.12 yields rose by 12 bps to 7.22 per cent in Q2. Sources: CCIL F-TRAC and RBI staff estimates. Yields on T-bills softened across tenors between end-March and end-September 2023, with market Among various maturity buckets, the 31-90 days expectations remaining anchored on unchanged segment had the largest share in fresh CP issuances policy rates (Chart IV.7). [45 per cent in H1 as against 49 per cent in H2:2022- 23] (Table IV.1). The trading volume in G-secs and T-bills increased in H1:2023-24 vis-à-vis H2:2022-23 (Chart IV.8). Over the IV.1.2 Government Securities (G-sec) Market During H1:2023-24, the 10-year G-sec yield softened same period, the weighted average yield on traded by 9 bps reflecting domestic as well as global factors G-secs declined by 20 bps while it increased by 15 bps (Chart IV.6). Yields eased in April-May 2023 due to for T-bills. Chart IV.6: 10-year Generic Yield, Repo Rate and Chart IV.7: FBIL -T-Bill Benchmark Liquidity Conditions (Yield to Maturity) Sources: RBI and FBIL. Source: FBIL. 58Chapter IV Financial Markets and Liquidity Conditions Chart IV.8: Trading Volumes and Yield a: G-Sec b: T-Bills Sources: CCIL and RBI Staff Estimates. The overall dynamics of the yield curve are captured increased more than in the short and long segments by its level, slope, and curvature2. During H1, the (Chart IV.9). In the Indian context, the level and average level of yields softened by 2 bps while, curvature of the yield curve are found to have more the slope steepened by 8 bps. The curvature rose information content on future macroeconomic by 2 bps as yields in the mid-segment of the curve outcomes than the slope, unlike in AEs.3 Chart IV.9: G-Sec Yield Curve a: Shifts b. Changes in Level and Slope Sources: FBIL and RBI Staff Estimates. 2 The level is the average of par yields of all tenors up to 30-years published by FBIL and the slope (term spread) is the difference in par yields of 3-months and 30-year maturities. The curvature is calculated as twice the 14-year yield minus the sum of 30-year and 3-month yields. 3 Patra, M.D., Joice, J., Kushwaha, K.M., and I. Bhattacharyya (2022), “What is the Yield Curve telling us about the Economy?”, Reserve Bank of India Bulletin, June. 59Monetary Policy Report October 2023 To facilitate debt consolidation, the Reserve Bank Chart IV.10: SGS - Amount Raised and Spread conducted six switch auctions on behalf of the Central 30,000 45 Government amounting to `51,597 crore during H1. The weighted average maturity (WAM) of the 25,000 40 outstanding stock of G-secs rose to 12.22 years at end- 20,000 35 September 2023 from 11.94 years at end-March 2023. 15,000 30 The weighted average coupon (WAC) at 7.28 per cent at end-September 2023 was marginally higher than 10,000 25 7.26 per cent as at end-March 2023. 5,000 20 The weighted average spread of cut-off yields on state government securities (SGS) over the G-sec yields of 0 15 comparable maturities was 24 bps in H1 (Chart IV.10). The average inter-state spread on securities of 10-year tenor (fresh issuances) was 1 bp in H1:2023-24 as against 4 bps in H2:2022-23. Source: RBI. IV.1.3 Corporate Bond Market Corporate bond yields softened and spreads narrowed sector undertakings (PSUs), financial institutions during H1:2023-24, mirroring G-sec yields. The (FIs) and banks softened by 10 bps to 7.65 per cent average yield on AAA-rated 3-year bonds issued (Chart IV.11a). The risk premium (the spread over by non-banking financial companies (NBFCs) and 3-year G-sec yields) moderated from 73 bps to 51 corporates declined by 29 bps (to 7.83 per cent) and 24 bps for NBFCs, from 68 bps to 51 bps for corporates bps (to 7.83 per cent), respectively, in September over and from 36 bps to 33 bps for PSUs, FIs and banks March 2023. The average yield on issuances by public (Chart IV.11b). 60 erorc(cid:31) 32-rpA-50 32-rpA-81 32-yaM-20 32-yaM-61 32-yaM-03 32-nuJ-31 32-nuJ-72 32-luJ-11 32-luJ-52 32-guA-80 32-guA-22 32-peS-50 32-peS-12 32-peS-62 stniopsisaB Totalaccepted amount Cumulative weighted average spread (RHS) Chart IV.11: AAA-rated 3-Year Corporate Bond Yield and Spreads a: Yield b: Spread Note: Data for spreads are monthly averages. Source: Fixed Income Money Market and Derivatives Association of India (FIMMDA).Chapter IV Financial Markets and Liquidity Conditions The reduction in risk premia was seen across tenors Table IV.2: Financial Markets - Rates and Spread and the rating spectrum (Table IV.2). The average 3-year credit default swap (CDS) spreads for the State Instrument Interest Rates Spread (bps) (per cent) (over corresponding Bank of India’s paper trading overseas reduced by 26 risk-free rate) bps while that of ICICI Bank moderated by 25 bps in H1:2023-24 over H2:2022-23. September March September September March September 2022 2023 2023 2022 2023 2023 Primary issuances of corporate bonds rose during H1 1 2 3 4 5 6 7 (up to August 2023) to `3.4 lakh crore – substantially Corporate Bonds higher than `1.9 lakh crore during the corresponding (i) AAA (1-yr) 6.87 8.08 7.68 12 66 53 period of 2022-23 – due to stable long term yields (ii) AAA (3-yr) 7.58 8.07 7.83 45 68 51 and cost advantage vis-a-vis bank loans (Chart (iii) AAA (5-yr) 7.54 8.00 7.69 23 57 37 (iv) AA (3-yr) 8.33 8.77 8.46 120 139 113 IV.12a). Overseas issuances, however, remained (v)BBB-minus 11.99 12.42 12.14 486 504 481 muted. Almost the entire resource mobilisation (3-yr) in the corporate bond market (97.6 per cent) was Note: Yields and spreads are computed as monthly averages. Source: FIMMDA. through the private placement route (up to August 2023). Outstanding investments by foreign portfolio marginally to `1.03 lakh crore at end-September 2023 investors (FPIs) in corporate bonds decreased from `1.04 lakh crore at end-March 2023 with the Chart IV.12: Corporate Bond Market Activity a: Domestic and Overseas Issuances b: FPI Investments in Corporate Bonds c: Secondary Market Turnover - Daily Average Sources: SEBI, NSDL, and Prime database. 61Monetary Policy Report October 2023 utilisation of the approved limits declining from 15.5 in equity prices. Overall, the BSE Sensex gained per cent to 15.4 per cent (Chart IV.12b). Secondary 11.6 per cent during H1 to close at 65,828. Equity market activity exhibited strong momentum, with market volatility was low, with the India VIX – which daily average trading volume during H1 (up to captures the short-term expected volatility of Nifty 50 August 2023) at `5,958 crore – 19.3 per cent higher – averaging 11.6 during H1 as compared with 15.1 in than `4,994 crore in the corresponding period of the H2:2022-23 (Chart IV.13a). The Indian equity markets previous year (Chart IV.12c). outperformed most EMEs and advanced economies (AEs) in H1 (Chart IV.13b). The 12-month trailing IV.1.4 Equity Market price-earnings ratio for the BSE Sensex at 23.0 as at Domestic equity markets remained buoyant in end-September 2023 was around its 10-year average. H1:2023-24 due to strong buying support from foreign Broader market indices outperformed the benchmark portfolio investors (FPIs), positive Q1 corporate Sensex with the BSE MidCap and BSE SmallCap indices earnings and a stable domestic economic outlook. rising by 34.4 per cent and 39.3 per cent, respectively, From late July, however, markets reversed some of during H1:2023-24. the earlier gains amidst weak global cues following Foreign investors remained net buyers in equities in the US sovereign rating downgrade and hawkish Fed H1, with the flows touching a 10-month high in June monetary policy messages. The markets resumed 2023. In contrast, flows from domestic institutional upward momentum in September amidst optimism investors (DIIs) were muted. Net purchases by DIIs and over moderating domestic inflation and positive FPIs amounted to `0.39 lakh crore and `1.41 lakh crore, industrial production data with the benchmark respectively in H1:2023-24 (Chart IV.14a). Despite an BSE Sensex closing at an all-time high of 67,839 on increase in the number of primary issuances, resource September 15, 2023. Thereafter, the US Fed's hawkish mobilisation in equity market declined to `0.51 lakh interest rate projections prompted some correction crore during H1 (up to August 2023) from `0.91 lakh Chart IV.13: Stock Market Performance a: Domestic Equity Market b: Global Equity Market Performance Source: Bloomberg. 62Chapter IV Financial Markets and Liquidity Conditions Chart IV.14: Institutional Investments and Resource Mobilisation a: Net Investment in Indian Equities by b. Resource Mobilisation in Equity Markets Institutional Investors Note: IPO- Initial Public Offer, FPO- Follow on Public Offer, QIP- Qualified Institutional Placement Sources: Capitaline, NSDL and SEBI. crore in the corresponding period of the previous year appreciating bias during April-July 2023, mainly on (Chart IV.14b). the back of stable macroeconomic fundamentals and revival in FPI flows. From August, the INR exhibited IV.1.5. Foreign Exchange Market a depreciation bias, with the US dollar strengthening The Indian rupee largely remained range-bound on the back of expectations about the US policy rate in H1:2023-24 (Chart IV.15a). It traded with an remaining higher for longer. The INR volatility – Chart IV.15: Indian Rupee and Volatility a: Movements of Indian Rupee and US Dollar b: 1 month At-the-Money (ATM) Implied Volatility Sources: FBIL; and Refinitiv Eikon. 63 136,05 199,06 462,88 541,13 486,24 223,55 041,32 227,63 395,12 519,82 100 ,000 80,000 60,000 40,000 20,000 0 H1:2021-22 H2:2021-22 H1:2022-23 H2:2022-23 H1:2023-24 (uptoAugust) erorc` IPOs, FPOs & Rights QIPs & PreferentialallotmentMonetary Policy Report October 2023 Chart IV.16: Cross-Currency Movements Table IV.3: Nominal and Real Effective Exchange against the US Dollar Rate Indices (Trade-weighted) (Base: 2015-16 = 100) 10 5 1.5 3.6 3.6 Item Index: Appreciation (+) / 0 End-September Depreciation (-) (Per cent) -5 -3.0 -1.0 2023 (P) End-September 2023 over -10 -6.7 -6.0 -6.0 -5.3 -5.2 -4.4 March (average) 2023 -15 40-currency REER 105.7 5.4 40-currency NEER 91.7 2.4 -20 -20.6 6-currency REER 104.7 6.0 -25 6-currency NEER 84.7 1.7 -30 -30.0 `/US$ 83.1 -0.9 -35 P: Provisional. -40 -40.3 Sources: RBI; and FBIL. -45 IV.1.6 Credit Market5 Bank credit6 growth remained strong in H1:2023-24 in Sources: FBIL; IMF; and Refinitiv Eikon. tandem with economic activity. Non-food bank credit extended by scheduled commercial banks (SCBs) rose measured by the 1-month at the money (ATM) option by 15.3 per cent (y-o-y) as on September 22, 2023 implied volatility4 – exhibited a declining tendency, over and above a growth of 16.9 per cent a year ago averaging 3.6 per cent during H1, down from 5.3 per (Chart IV.18). cent during H2:2022-23 (Chart IV.15b). Between end-March and end-September 2023, the Chart IV.17: Movements in Forward Premia INR depreciated by 1.0 per cent against the US dollar although it outperformed many EME currencies like the Argentina Peso, the Turkish Lira, the Russian Ruble, the Thai Baht and the Malaysian Ringgit (Chart IV.16). In terms of the 40-currency real effective exchange rate, the INR appreciated by 5.4 per cent between March and end-September 2023 (Table IV.3). Forward premia eased across tenors during H1:2023- 24, driven by narrowing interest rate differentials. The 1-month forward premia declined to an average of 1.42 per cent in H1 from 2.38 per cent during H2:2022- 23 while the 12-month premia fell to 1.87 per cent Source: Bloomberg. from 2.25 per cent over the same period (Chart IV.17). 4 Implied volatility is derived from an option’s price and depicts the markets’ expectations about the future volatility of the currency. 5 While overall bank credit and non-food credit data are based on Section-42 return (which covers all SCBs), sectoral non-food credit data are based on sector-wise and industry-wise bank credit (SIBC) return, which covers select banks accounting for about 93 per cent of total non-food credit extended by all SCBs. 6 Data on banking and select monetary aggregates exclude the impact of merger of a bank with a non-bank. 64 egnahcegatnecreP anitnegrA yekruT aissuR dnaliahT aisyalaM anihC nawiaT acirfAhtuoS senippilihP aisenodnI aidnI lizarB ocixeM )YXD(SU 4.0 3.5 3.0 2.5 2.0 1.5 1.0 tnec reP 22-tcO-10 22-tcO-61 22-tcO-13 22-voN-51 22-voN-03 22-ceD-51 22-ceD-03 32-naJ-41 32-naJ-92 32-beF-31 32-beF-82 32-raM-51 32-raM-03 32-rpA-41 32-rpA-92 32-yaM-41 32-yaM-92 32-nuJ-31 32-nuJ-82 32-luJ-31 32-luJ-82 32-guA-21 32-guA-72 32-peS-11 32-peS-92 1month 3months 6months 12monthsChapter IV Financial Markets and Liquidity Conditions à-vis PSBs (14.4 per cent) (Chart IV.19a). PSBs were, Chart IV.18: Non-food Credit Growth of SCBs however, the major driver of incremental bank credit (Chart IV.19b). Sector-wise, services and personal loans were the key avenues of bank credit deployment and their share in total incremental credit offtake rose in H1:2023-24 vis- à-vis the same period of the previous year. Personal loans and services credit contributed 37.7 per cent and 36.9 per cent, respectively, of incremental bank credit (y-o-y) in August 2023 (Chart IV.20). Bank lending to agriculture sector remained buoyant, with a growth of 16.6 per cent (y-o-y) in August 2023. Credit growth to industry decelerated to 6.1 per cent in August 2023, with flows to MSMEs (10.1 per cent) Source: RBI. exceeding those to large industries (4.8 per cent). All the major industries, barring textiles and basic metals, Credit growth remained higher for private sector experienced a slowdown in credit growth relative to banks (PVBs) (18.1 per cent as on September 22) vis- August 2022. Credit growth to the infrastructure Chart IV.19: Credit Flow across Bank Groups a: Growth b: Share in Incremental Credit 23 18.1 17 14.4 15.3 11 5 0.4 -1 Source: RBI. 65 )y-o-y(tnec reP 12-raM 12-nuJ 12-peS 12-ceD 22-raM 22-nuJ 22-peS 22-ceD 32-raM 32-nuJ 32-peS Publicsector banks (includingregionalrural banks) Privatebanks (including small financebanks) Foreign banks AllSCBsMonetary Policy Report October 2023 Chart IV.20: Sectoral Deployment of Bank Credit 30 25 20.7 20 18.3 16.6 15 15.0 10 6.1 5 0 Aug-21 Oct- 2 1 Dec- 21 Feb-22 Apr-22 Jun-22 Aug-22 Oct- 2 2 Dec- 22 Feb-23 Apr-23 Jun-23 Aug-23 Source: RBI. sector weakened, mainly due to decline in credit to Services sector credit expanded by 20.7 per cent (y-o-y) the power and telecom sectors (Chart IV.21). in August, led by NBFCs. Within services, credit growth 66 tnecreP a: Non-food Credit Growth (y-o-y) b: Share in Incremental Non-food Credit Non-food credit Agriculture Industry Services Personal loans Chart IV.21: Bank Credit in Industry Sector – Size-wise and Type-wise b: Incremental Credit (y-o-y) d: Credit Growth (y-o-y) - Infrastructure Sector 85 70 55 40 25 18.3 10 11.7 1.2 -5 1.1 -20 -11.4 Source: RBI. tnec reP 12-guA 12-tcO 12-ceD 22-beF 22-rpA 22-nuJ 22-guA 22-tcO 22-ceD 32-beF 32-rpA 32-nuJ 32-guA a: Size-wise Credit Growth (y-o-y) c: Credit Growth to Industrial Sector (y-o-y) - Major Constituents Textiles Petroleum Chemicals Metals InfrastructureChapter IV Financial Markets and Liquidity Conditions Chart IV.22: Credit Growth in Services Sector (y-o-y) a: Major Constituents of Services Sector b: Bank Credit to NBFCs Source: RBI. to commercial real estate and transport operators also to 20.6 per cent. Credit card loans maintained high improved (Chart IV.22). growth (30.0 per cent in August) reflecting inter alia the buoyancy in demand from contact-intensive Retail loans rose by 18.3 per cent (y-o-y) in August services (Chart IV.23). and remained the prime contributor of overall credit growth. Credit to the housing sector recorded The composition of bank credit has witnessed consistent double-digit expansion (13.8 per cent substantial change over time, with an increasing in August) while vehicle loan growth strengthened proportion of credit now going to services and retail Chart IV.23: Personal Loans Growth (y-o-y) Chart IV.24: Sectoral Bank Credit - Compositional Change Source: RBI. Source: RBI. 67Monetary Policy Report October 2023 loans relative to industry (Chart IV.24). Amidst on GDP growth appears to have strengthened these structural changes, the impact of bank credit (Box IV.1). Box IV.1: Bank Credit and Growth Dynamics In a bank-based economy like India, bank credit serves the period 2000-2023 and for the sub-period 2008-2023 as an important input in sustaining the growth indicate that: (i) credit shocks appear to have turned less momentum and is a key conduit for monetary policy persistent in the latter period (i.e., 2008-2023); (ii) bank transmission (Samargandi and Kutan, 2016). Impulse credit continues to have a positive effect on growth and responses from a structural vector autoregression its impact has somewhat strengthened over time; and (SVAR) model – including the following variables: GDP (iii) the effect of a monetary policy (interest rate) shock growth; CPI inflation; weighted average call rate; real has become more pronounced, albeit less persistent non-food credit growth; and bank capital growth – for (Chart IV.I.1). Chart IV.I.1: Bank Credit and Monetary Policy Shocks and GDP Growth: Impulse Responses Full sample (2000 – 2023) Recent sample (2008 – 2023) Credit shock Response of GDP to credit shock Response of GDP to monetary policy shock Note: The grey areas represent two-third of the identified posterior distribution. x-axis is horizon (quarters ahead) and y-axis is percentage points. Sources: RBI staff estimates. (Contd.) 68Chapter IV Financial Markets and Liquidity Conditions A historical decomposition based on the SVAR indicates Chart IV.I.2: Historical Decomposition of that the drag from the contraction in real credit on GDP Growth GDP growth is fast diminishing and the recent positive trajectory of real bank credit should provide tailwinds to domestic demand in the ensuing quarters (Chart IV.I.2). References Samargandi, N., and A.M. Kutan (2016), “Private Credit Spillovers and Economic Growth: Evidence from BRICS Countries”, Journal of International Financial Markets, Institutions and Money, 44, 56-84. Note: Shocks are defined as follows: AD shock increases output, inflation and credit; Uhlig, H., (2005), “What are the Effects of Monetary AS shock increases inflation but decreases GDP and credit; MP shock increases WACR but decreases inflation, GDP and credit; NFC shock captures exogenous Policy on Output? Results from an Agnostic Identification increase in credit; DC shock moves GDP and credit in opposite direction and hence captures the decoupling between the two. Procedure”, Journal of Monetary Economics 52 (2), pp. Source: RBI staff estimates. 381-419. The asset quality of SCBs improved during H1:2023- Amidst sustained growth in bank credit, banks’ 24, with the overall non-performing assets (NPA) ratio non-SLR investments (i.e., investments in CPs, and declining to 3.7 per cent in June 2023 from 5.7 per bonds, debentures and shares of public and private cent a year ago (Chart IV.25a). Asset quality improved corporates) declined in H1:2023-24 as against an across all the major sectors over the same period increase in H1:2022-23. The growth in adjusted (Chart IV.25b). non-food credit (i.e., non-food bank credit plus Chart IV.25: Stressed Assets and Non-Performing Assets of SCBs a: Overall Loan Portfolio of SCBs b: Sectoral Non-Performing Assets Source: RBI. 69Monetary Policy Report October 2023 Chart IV.26: Non-SLR Investments and Adjusted Non-Food Credit a: Non-SLR Investment b: Adjusted Non-Food Credit Source: RBI. non-SLR investments) moderated to 14.4 per cent 2023 as compared with 8.7 per cent at end-March 2023 (y-o-y) as on September 22, 2023 from 15.1 per cent (Chart IV.27). Excess SLR holdings provide collateral in the corresponding period of the previous year buffers to banks for availing funds under the LAF (Chart IV.26b). and from collateralised markets. They are also a component of the liquidity coverage ratio. The excess holdings of statutory liquidity ratio (SLR) securities by banks was 8.8 per cent of their net IV.2 Monetary Policy Transmission demand and time liabilities (NDTL) as on August 25, Bank lending and deposit rates rose further in H1:2023-24, reflecting the lagged impact of the policy rate hikes during May 2022-February 2023, Chart IV.27: Excess SLR of Banks the external benchmark-based lending rate (EBLR) system of loans pricing and the moderation of surplus liquidity. In response to the 250 bps increase in the policy repo rate since May 2022, the weighted average lending rates (WALRs) on fresh and outstanding rupee loans increased by 196 bps and 112 bps, respectively, during May 2022-August 2023. On the deposit side, the weighted average domestic term deposit rates (WADTDRs) on fresh and outstanding term deposits rose by 233 bps and 157 bps, respectively, over the same period. The transmission to outstanding term deposits during H1:2023-24 (up to August) at 44 bps outpaced transmission on the lending side (12 bps), with the repricing of an increasing proportion of term *up to August 25, 2023. Source: RBI. deposits at higher rates (Table IV.4). 70Chapter IV Financial Markets and Liquidity Conditions Table IV.4: Transmission from the Repo Rate to Banks’ Deposit and Lending Rates (Variation in basis points) Period Repo Term Deposit Rates Lending Rates Rate WADTDR WADTDR WADTDR EBLR 1 - Year WALR WALR (Fresh (Fresh (Outstanding MCLR (Fresh (Outstanding Deposits) Deposits) Deposits) (Median) Rupee Rupee Loans) Loans) Retail Deposits Retail and Bulk Deposits February 2019 to March 2022 -250 -209 -259 -188 -250 -155 -232 -150 April 2022 to August/September 2023* 250 168 224 157 250 158 184 110 Of which, April 2022 0 0 -9 0 0 0 -12 -2 May 2022 to August/September 2023* 250 168 233 157 250 154 196 112 April 2023 to August/September 2023* 0 -6 -12 44 - 15 15 12 Notes: 1. WALR: Weighted average lending rate; WADTDR: Weighted average domestic term deposit rate; EBLR: External benchmark-based lending rate; MCLR: Marginal cost of funds-based lending rate. 2. Data on EBLR pertain to 32 domestic banks. * : Latest data on WALRs and WADTDRs pertain to August 2023. Source: RBI. EBLR loans now dominate the floating rate loans. Chart IV.28: Outstanding Floating Rate Rupee Their share increased from 44.0 per cent in March Loans of SCBs across Interest Rate Benchmarks 2022 to 50.2 per cent in June 2023, while that of MCLR-linked loans declined from 48.6 per cent to 44.8 per cent during the same period (Chart IV.28). The increasing share of EBLR-linked loans with shorter reset periods and the increase in the MCLRs aided transmission to WALR on outstanding loans of SCBs. Bank-group wise, the proportion of EBLR- linked loans was the highest in the case of foreign banks (87.6 per cent), followed by PVBs (73.2 per cent) and PSBs (36.1 per cent). The transmission to WALR on fresh rupee loans during Notes: 1. ‘Others’ include base rate, benchmark prime lending rate and other May 2022 to August 2023 was higher in the case of internal benchmarks. 2. Data pertain to 73 scheduled commercial banks. PSBs relative to PVBs, while transmission to lending Source: RBI. rates on outstanding rupee loans was higher for PVBs (Chart IV.29a). The lending rates of PVBs remained case of foreign banks, reflecting a higher share of low- above those of PSBs (Chart IV.29b). The maximum cost and lower duration wholesale deposits in their transmission to lending and deposit rates was in the total liabilities and a high share of EBLR-linked loans. 71Monetary Policy Report October 2023 Chart IV.29: Bank Group wise Transmission to Lending Rates 350 323 300 250 203 196 186 200 163 146 155 153 150 135 104117 112 100 50 0 WALR (Freshrupee WALR (Outstanding 1-Year Median MCLR loans) rupee loans) Source: RBI. Sector-wise, the WALR on fresh rupee loans rose by fresh loans rose by 173 bps for MSMEs loans, by 159 213 bps for large industry, 128 bps for MSMEs and bps for vehicle loans, and by 127 bps for housing loans 113 bps for housing loans (Chart IV.30a). For floating (Chart IV.30b). rate loans mandatorily linked to EBLR, the WALR on Chart IV.30: Sector-wise Transmission to WALRs of Domestic Banks (May 2022 to August 2023) Source: RBI. 72 stniopsisaB Publicsector banks Privatebanks Foreign banks SCBs 250 201 213 211 200 179 186 168 154 150 128 140 130 136 113 119 111 100 104 96 73 103 83 83 100 108 49 50 31 0 stniopsisaB gnisuoH elciheV noitacudE snaoL lanosreP rehtO sEMSM erutlucirgA )egraL( yrtsudnI erutcurtsarfnI edarT secivreSlanoisseforP tiderC tropxE eepuR llarevO 200 186 187 185 170 172173 159 150 127 131 114 108 100 50 0 -17 -50 Housing Vehicle Education MSME Loans Freshrupee loans Outstandingrupee loans stniopsisaB a: Transmission during May 2022 to August 2023 b: Lending Rates of Domestic Banks a: Transmission to WALR on Loans b: Transmission to WALR on Fresh Floating Rate (Fixed and Floating) Rupee Loans Mandatorily Linked to EBLR Public sector banks Privatebanks Domestic banksChapter IV Financial Markets and Liquidity Conditions The WADTDR on fresh term deposits declined during H1:2023-24 while that on outstanding deposits rose with an increasing proportion of deposits getting renewed at higher deposit rates. Across bank groups, the transmission to WADTDR on fresh deposits was higher for PSBs as compared with PVBs. Across tenors, the maximum increase was observed for shorter maturities (up to 180 days) (Chart IV.31). While the increase in term deposit rates in the current tightening cycle has exceeded that in lending rates (both in terms of fresh and outstanding deposits/ loans), the savings deposit rates of banks – which are a third of total deposits – have remained almost unchanged, while current account balances (share of In the case of repo rate-linked loans, the spreads of 9.6 per cent in total deposits) earn no interest. This WALR (fresh loans) over the policy repo rate narrowed, has moderated the increase in the banks’ overall thereby moderating the transmission to actual lending cost of funds and is mirrored in higher net interest rates on new loans (Table IV.5). margins (Chart IV.32). Chart IV.31: Transmission to Deposit Rates 300 271 264 242 250 233 195 200 174 168 151152 157 154 150 97 100 50 0 WADTDR WADTDR WADTDR (Outstandingdeposits) (Fresh retaildeposits) Source: RBI. 73 stniopsisaB Table IV.5: Loans linked to External Benchmark – Spread of WALR (Fresh Loans) over the Repo Rate (Per cent) Sectors April-2022 August-2023 Public Private Domestic Public Private Domestic sector banks banks sector banks banks banks banks MSME loans 4.27 3.93 4.04 3.62 3.15 3.27 Personal loans Housing 2.91 3.32 3.21 2.27 1.90 1.98 Vehicle 3.37 4.39 3.55 2.57 3.03 2.64 Education 4.42 5.71 4.71 3.79 3.04 3.52 Other personal 3.54 7.35 4.01 3.43 3.26 3.41 loans Sources: RBI; and RBI staff estimates. a: Transmission during May 2022 to August 2023 b: Maturity wise Transmission to WADTDR on Fresh Deposits (May 2022 to August 2023) (Fresh deposits) Public sector banks Private banks Foreign banks SCBsMonetary Policy Report October 2023 Chart IV.32: Speed of Transmission to Lending and Deposit Rates and Rigidities in Savings Deposit Rate b: Speed of Transmission (Outstanding Loans and Deposits) 300 250 200 150 100 50 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 d: NIM of Scheduled Commercial Banks *: Based on card rates of domestic banks. Source: RBI. The Government of India (GOI) raised the interest rates on small savings instruments (SSIs), which 74 noissimsnartevitalumuC )stniopsisab( a: Speed of Transmission (Fresh Loans and Deposits) 300 250 200 150 100 50 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 Monthsintotighteningcycle RepoRate WADTDR (Outstanding deposit) WALR(Outstanding loans) c: Savings Deposit Rates of Banks are linked to secondary market yields on G-secs of comparable maturities, by 40-150 bps in five successive quarters beginning Q3:2022-23 (Chart IV.33). With these revisions, the actual interest rates on most SSIs Chart IV.33: Increase in Interest Rates on Bank Deposits and Small Savings Schemes are now better aligned with the formula-based rates (May 2022-September 2023) (Table IV.6). IV.3 Liquidity Conditions and the Operating Procedure The Reserve Bank of India (RBI) Act, 1934 requires the RBI to place the operating procedure relating to the implementation of monetary policy and changes thereto from time to time, if any, in the public domain. During H1:2023-24, the monetary policy committee (MPC) kept the policy repo rate unchanged at 6.5 per cent and continued with the stance of withdrawal of accommodation (see Chapter I). In consonance *: Pertains to May 2022 to August 2023. with the monetary policy stance, the increase in Sources: Government of India; and RBI staff estimates. surplus liquidity (as discussed below) and the risks noissimsnartevitalumuC )stniopsisab( Monthsintotighteningcycle RepoRate WADTDR (Fresh Deposit) WALR(Fresh Loans)Chapter IV Financial Markets and Liquidity Conditions Table IV.6: Interest Rates on Small Savings Instruments – Q3:2023-24 Small Savings Scheme Maturity Spread Average G-sec Formula based Government Difference (years) (Percentage Yield (%) of Rate of Interest Announced Rate (basis points) point) $ Corresponding (%) (applicable of Interest (%) in Maturity for Q3:2023-24) Q3:2023-24 (Jun to Aug 2023) (1) (2) (3) (4) (5) = (3) + (4) (6) (7) = (6) - (5) Savings Deposit - 4.0 - Public Provident Fund 15 0.25 7.26 7.51 7.1 -0.41 Term Deposits 1 Year 1 0 6.76 6.76 6.9 0.14 2 Year 2 0 6.84 6.84 7.0 0.16 3 Year 3 0 6.91 6.91 7.0 0.09 5 Year 5 0.25 7.07 7.32 7.5 0.18 Recurring Deposit Account 5 0 6.91 6.91 6.7 -0.21 Monthly Income Scheme 5 0.25 7.03 7.28 7.4 0.12 Kisan Vikas Patra 115 Months# 0 7.26 7.26 7.5 0.24 NSC VIII issue 5 0.25 7.26 7.51 7.7 0.19 Senior Citizens Saving Scheme 5 1 7.07 8.07 8.2 0.13 Sukanya Samriddhi Account Scheme 21 0.75 7.26 8.01 8.0 -0.01 $: Spreads for fixing small saving rates as per Government of India Press Release of February 2016. #: Current maturity is 115 months. Note: Compounding frequency varies across instruments. Sources: Government of India; FBIL; and RBI staff estimates. to price and financial stability from excess liquidity, Drivers and Management of Liquidity the Reserve Bank imposed an incremental cash During H1, liquidity conditions were impacted reserve ratio (I-CRR) of 10 per cent, effective from the substantially by the return of currency to the banking fortnight beginning August 12, 2023, on the increase system following the Reserve Bank’s decision on May in NDTL of all scheduled banks between May 19 and 19 to withdraw `2,000 banknotes from circulation. July 28, 20237. It was indicated that the I-CRR would In Q1, surplus liquidity shrank between April and be reviewed on or before September 8, 2023 with a mid-May with the seasonal expansion in currency in view to return the impounded funds to the banking circulation (CiC) and the build-up of government cash system ahead of the festival season. On a review on balances. Between the third week of May and up to September 8, the I-CRR was discontinued in a phased mid-June, liquidity conditions improved due to the manner so that system liquidity is not subjected to (i) the return of `2,000 banknotes from circulation sudden shocks and money markets function in an (Chart IV.34), (ii) an accelerated pace of Government orderly manner: 25 per cent of the impounded I-CRR spending before the onset of the monsoon season; and funds was released on September 9 and another 25 (iii) the Reserve Bank’s market operations. Advance per cent on September 23 and the remaining 50 per tax payments and GST related outflows moderated cent are to be released on October 7. surplus liquidity in the second half of June 2023. In 7 The existing cash reserve ratio (CRR), however, remained unchanged at 4.5 per cent. 75Monetary Policy Report October 2023 balances due to advance tax collections and GST Chart IV.34: Currency in Circulation (CiC) payments tightened liquidity conditions, particularly 50,000 in the second half of September. Overall, net average 40,000 absorption under the LAF at `1.1 lakh crore in H1 30,000 was higher than `0.4 lakh crore in H2:2022-23. Of the 20,000 average total absorption of about `1.6 lakh crore in H1, 10,000 `1.1 lakh crore (about 72 per cent) was through the 0 standing deposit facility (SDF) while the remaining -10,0 00 was mopped up through variable rate reverse repo -20,000 (VRRR) operations – both main and fine-tuning – of -30,000 -40,0 00 various tenors. -50,000 Overall, the build-up of government cash balances moderated surplus liquidity in H1 which was largely replenished by the return of currency to the banking Source: RBI. system and the RBI’s market operations (Table IV.7). In terms of liquidity management, absorptions under the LAF and increase in reserve requirements (through Q2, liquidity surplus rose amidst the continued return I-CRR) were the main instruments for mopping up the of `2,000 banknotes, with the net average absorption liquidity surplus. under the LAF increasing from `0.8 lakh crore in May 2023 to `1.6 lakh crore in July. With the I-CRR coming Borrowings under the MSF averaged `29,287 crore into effect from August 12, system liquidity, although in H1, higher than `8,438 crore in H2:2022-23, somewhat moderating, remained in surplus barring peaking at `1.99 lakh crore on September 21. Net a few days. Thereafter, build-up of government cash LAF (inclusive of MSF) slipped into deficit (injection Table IV.7: Liquidity – Key Drivers and Management (` crore) Drivers 2022-23 2023-24* Q1 Q2 H1 Q1 Q2* Drivers (i) CiC [withdrawal (-) /return (+)] -83,887 59,283 -24,604 18,103 71,501 (ii) Net Forex Purchases (+)/ Sales (-) 16,159 -2,89,713 -2,73,554 1,60,738 16,352# (iii) GoI Cash Balances [build-up (-) / drawdown (+)] -2,64,512 64,651 -1,99,861 -2,37,937 -23,616# (iii) Excess Reserves [build-up (-) / drawdown (+)] 1,50,165 -54,446 95,719 -31,485 6,520# Management (i) Net OMO Purchases (+)/ Sales (-) -6,620 -14,460 -21,080 0 -8,480 (ii) Required Reserves [including both change in NDTL and I-CRR] -1,03,054 -13,946 -1,17,000 -33,712 -1,01,508 Memo Item (iii) Outstanding Net LAF as at the end of period [absorption (+)/injection (-)] 3,34,814 54,110 54,110 1,62,906 -97,015 *: Data are up to September 29, 2023 #: Data up to July 28, 2023. Note: (+) / (-) sign suggests accretion/depletion in banking system liquidity. Data on drivers and management pertain to the last Friday of the respective period. Source: RBI. 76 )erorc(cid:31)(snoitairaVylkeeW 32-rpA-70 32-rpA-41 32-rpA-12 32-rpA-82 32-yaM-50 32-yaM-21 32-yaM-91 32-yaM-62 32-nuJ-20 32-nuJ-90 32-nuJ-61 32-nuJ-32 32-nuJ-03 32-luJ-70 32-luJ-41 32-luJ-12 32-luJ-82 32-guA-40 32-guA-11 32-guA-81 32-guA-52 32-peS-10 32-peS-80 32-peS-51 32-peS-22 32-peS-92 Withdrawalof(cid:31)2000 banknotes 2022-23 2023-24Chapter IV Financial Markets and Liquidity Conditions improvement in liquidity conditions, a 14-day variable Chart IV.35: Standing Facilities- SDF and MSF rate reverse repo (VRRR) auction (main operation) of 4 `2.0 lakh crore was conducted on June 2 to absorb 3 liquidity, followed by five fine tuning operations during June 5-13 of varying sizes – between `0.50 lakh 2 crore to `1.0 lakh crore – with maturities between 2-4 1 days. To alleviate the liquidity stress caused by advance tax payments and GST outflows in the second half 0 of June, a VRR fine tuning operation was conducted on June 19 injecting `75,004 crore into the banking -1 system. With increased aversion among banks to park -2 surplus funds for longer tenors, the Reserve Bank conducted six-fine tuning VRRR operations of 1-4 days maturity in July of size `1.0-2.0 lakh crore. Overall, 12 VRRR main operations and 11 VRRR fine tuning Source: RBI. operations along with one VRR main operation and one VRR fine tuning operation were conducted in mode) on August 21 for the first time in 2023-24 and H1. The fine-tuning operations, on average, elicited remained so till August 23; therafter, it again turned into deficit mode from the second half of September. better response from banks relative to the fortnightly On a monthly basis, net LAF slipped into deficit in 14-day main operations, with average bid-cover ratios September 2023 - the first time since May 2019 - with of 0.46 and 0.35, respectively, in H1 (Chart IV.36). an average daily net injection of `0.15 lakh crore. At Banks need to hone their liquidity forecasting skills the overall level, the deployment of large surplus to efficiently assess liquidity requirements over the funds under the SDF and simultaneous recourse reserve maintenance cycle and bid accordingly in the to the MSF was symptomatic of skewed liquidity main operation auctions, since fine tuning operations distribution within the banking system (Chart IV.35). are neither a substitute of the main operation nor The frictional liquidity conditions led to the WACR are they standing facilities – they are conducted at breaching the MSF rate on 18 occassions in H1:2023- the discretion of the central bank as per operational 24 – six in May; three in June; five in August; and four requirements. in September with the average spread (over the MSF) Reserve money (RM) expanded by 6.4 per cent (y-o-y) on these days at 3 bps. as on September 29, 2023 as compared with 12.9 per During H1:2023-24, the Reserve Bank’s liquidity cent a year ago (5.0 per cent adjusted for the first-round management involved two-way operations. To assuage impact of the change in the CRR as against 10.3 per the liquidity tightness in the middle of May, a 14-day cent a year ago). Money supply (M3) increased by 10.8 variable rate repo (VRR) auction (main operation) was per cent (y-o-y) as on September 22, 2023 as compared conducted to inject liquidity amounting to `50,000 with 8.6 per cent in the corresponding period of the crore on May 19, 2023. Subsequently, however, with an previous year (Table IV.8). 77 erorchkal(cid:31) 32-rpA-2 32-rpA-8 32-rpA-41 32-rpA-02 32-rpA-62 32-yaM-2 32-yaM-8 32-yaM-41 32-yaM-02 32-yaM-62 32-nuJ-1 32-nuJ-7 32-nuJ-31 32-nuJ-91 32-nuJ-52 32-luJ-1 32-luJ-7 32-luJ-31 32-luJ-91 32-luJ-52 32-luJ-13 32-guA-6 32-guA-21 32-guA-81 32-guA-42 32-guA-03 32-peS-5 32-peS-11 32-peS-71 32-peS-32 32-peS-03 Imposition of I-CRR SDF MSF NetLAFMonetary Policy Report October 2023 Chart IV.36: Bid-Cover Ratio of Variable Rate Reverse Repo Operations 1.0 0.88 0.9 0.8 0.67 0.67 0.7 0.64 0.58 0.6 0.53 0.5 0.43 0.39 0.4 0.3 0.2 0.2 0.06 0.1 0.02 0 Source: RBI. 78 3202 ,50nuJ 3202 ,60nuJ 3202 ,70nuJ 3202 ,90nuJ 3202 ,31nuJ 3202 ,3luJ 3202 ,4luJ 3202 ,5 luJ 3202 ,6 luJ 3202 ,7 luJ 3202,11luJ a: Main Operation- Variable Rate Reverse Repo b: Fine Tuning Operations rates, notwithstanding intermittent bouts of Table IV.8: Banking and Monetary Aggregates volatility, remained range-bound across segments, (Y-o-y growth, per cent) instruments, and the maturity spectrum. Bank credit Indicator March March June September 2022 2023 2023 2023 offtake was sustained, supporting resilient economic Reserve money* (Adjusted 13.0 10.0 6.3 6.4 activity. Bank lending and deposit rates exhibited for CRR changes) (10.3) (7.6) (6.3) (5.0) a staggered but still incomplete adjustment to the Broad money (M3) 8.8 9.0 11.3 10.8 Currency in circulation* 9.8 7.8 4.9 4.1 past rate hikes. The INR remained broadly stable Aggregate deposits 8.9 9.6 13.0 12.3 and outperformed several of its EME peers. The Demand deposits 11.4 5.2 19.4 11.0 Time deposits 8.6 10.2 12.1 13.5 large liquidity accretion following the withdrawal of Bank credit 9.6 15.0 16.2 15.3 `2,000 banknotes from circulation was proactively *: As on September 29, 2023. managed by the Reserve Bank through multiple Note: Data on broad money, deposit and credit growth exclude the impact of merger of a bank with a non-bank. instruments. Going forward, the Reserve Bank Source: RBI. will remain agile and nimble in conducting IV.4 Conclusion market operations to ensure financial stability Domestic financial market conditions evolved while providing liquidity to meet the productive in an orderly manner in H1:2023-24. Market requirements of the economy.V. External Environment The global economy is slowing. Headline inflation remains above target in major economies, prompting central banks to persist with monetary tightening. Uncertainty about the monetary policy trajectory is imparting volatility to global financial markets. Stubborn core inflation, tightening financial conditions, high public debt, geopolitical tensions, geoeconomic fragmentation and extreme weather events pose downside risks to the global growth outlook. The global economy is slowing, with divergent growth of 2.8 per cent, with the projection for 2024 retained trajectories across countries and sectors. Headline at 3.0 per cent. The global growth in 2023-2024 is inflation is easing unevenly but it remains above expected to be sizeably below the 2022 outturn (3.5 targets in major economies, while core inflation per cent) and the historical average (2000 to 2019) of (headline excluding food and energy) remains elevated. 3.8 per cent1. Major central banks have accordingly persisted with Amongst the advanced economies (AEs), the US monetary tightening during April-September, albeit economy grew by 2.1 per cent (quarter-on-quarter, with some moderation in the pace. Financial markets seasonally adjusted annualised rates (q-o-q, saar)) in remain unsettled, anticipating ‘higher for longer’ Q2:2023, similar to its Q1 outturn (2.2 per cent) (Table stances in the future conduct of monetary policy. V.1). This growth was driven by non-residential fixed Sovereign bond yields have firmed up while the US investment, consumer spending, and government dollar is exhibiting sharp two-way movements since spending, though exports and residential fixed the April 2023 MPR. Global equity markets gained investment contracted. Tightness in the labour market during April-July 2023 on optimism about an early end persisted, with the unemployment rate at 3.8 per cent to monetary tightening but have corrected recently on in August. The US composite S&P global purchasing expectations of more monetary policy actions. Risks managers’ index (PMI2) at 50.2 in September 2023 to global growth prospects are tilted to the downside. signalled its weakest performance since February V.1 Global Economic Conditions 2023. Global growth appears to have lost pace in the third In the euro area, real GDP growth remained subdued quarter of 2023, dragged down by tight financial at 0.5 per cent (q-o-q, saar) in Q2 (0.2 per cent in Q1) conditions, high inflation weighing on consumer due to flat household consumption demand and spending, slowdown in the Chinese economy contraction in exports. Services exhibited resilience, and renewed geopolitical hostilities. Lacklustre benefitting from strong demand for tourism and manufacturing and trade is holding back the revival, other leisure-related activities. The Eurozone offsetting relatively robust services expansion. The composite PMI remained in contraction for the fourth International Monetary Fund (IMF) in its World consecutive month at 47.2 in September due to Economic Outlook (WEO) update of July 2023 revised deteriorating demand and a sharp drop in new orders. up the global growth projection for 2023 by 20 basis The unemployment rate was 6.4 per cent in August points (bps) to 3.0 per cent from its April projection 2023, broadly comparable with 6.5 per cent in March. 1 The OECD in its Interim Economic Outlook (September 2023) revised up global growth forecast for 2023 to 3.0 per cent and revised it down to 2.7 per cent for 2024 from June 2023 projections of 2.7 per cent and 2.9 per cent, respectively. 2 The references to PMIs are to S&P Global indices, unless specified otherwise. 79Monetary Policy Report October 2023 since late-2021. The UK composite PMI at 48.5 in Table V.1: Real GDP Growth (Per cent) September was the weakest since January 2023 and signalled a reduction in private sector output amidst Country Q3- Q4- Q1- Q2- 2022 2023 2024 2022 2022 2023 2023 (P) (P) weak manufacturing activity. Japan’s GDP growth Quarter-on-quarter, seasonally adjusted, annualised rate (q-o-q, saar) accelerated from 3.2 per cent in Q1:2023 (q-o-q, saar) Canada 2.2 -0.1 2.6 -0.2 - - - to 4.8 per cent in Q2, led by car exports and inbound Euro area 1.3 -0.2 0.2 0.5 - - - tourism benefiting from a weaker yen. The composite Japan -1.2 0.2 3.2 4.8 - - - South Korea 0.9 -1.2 1.3 2.5 - - - PMI (au Jibun Bank) remains in expansion since the UK -0.3 0.5 1.3 0.8 - - - beginning of 2023, though it declined from 52.9 in US 2.7 2.6 2.2 2.1 - - - April 2023 to 52.1 in September. Year-on-year Amongst emerging market economies (EMEs), China’s Advanced Economies real GDP moderated to 3.2 per cent (q-o-q, saar) in Canada 3.8 2.1 2.1 1.1 3.5 1.7 1.4 Euro area 2.3 1.7 1.1 0.5 3.3 0.9 1.5 Q2 from 9.1 per cent in Q1. The upturn in economic Japan 1.5 0.4 2.0 1.6 1.1 1.4 1.0 activity following the reopening of the economy South Korea 3.2 1.4 0.9 0.9 2.6 1.4 2.4 waned amidst weakened consumer spending, lower UK 2.1 0.7 0.5 0.6 4.3 0.4 1.0 US 1.7 0.7 1.7 2.4 1.9 1.8 1.0 exports and the beleaguered real estate sector. The Emerging Market Economies composite PMI (Caixin) slowed to a 9-month low at 50.9 in September, as both manufacturing and services Brazil 3.6 1.9 4.0 3.4 2.9 2.1 1.2 China 3.9 2.9 4.5 6.3 3.0 5.2 4.5 PMIs moderated despite remaining in expansionary India 6.2 4.5 6.1 7.8 7.2 6.1 6.3 territory, with the latter falling more sharply. Chinese Indonesia 5.7 5.0 5.0 5.2 5.3 5.0 5.0 Philippines 7.7 7.1 6.4 4.3 7.6 6.2 5.5 economy is projected by the IMF to grow by 5.2 per Russia -3.5 -2.7 -1.8 4.9 -2.1 1.5 1.3 cent in 2023 and 4.5 per cent in 2024 (Table V.2). China South Africa 4.1 0.8 0.2 1.6 1.9 0.3 1.7 undertook monetary easing and provided regulatory Thailand 4.6 1.4 2.6 1.8 2.6 3.4 3.6 relaxation for its real estate sector to stimulate the Memo: economy. World 2022 2023 (P) 2024 (P) Amongst other major EMEs, Brazil’s GDP growth Year-on-year decelerated from 4.0 per cent (y-o-y) in Q1:2023 to 3.4 Output 3.5 3.0 3.0 Trade Volume 5.2 2.0 3.7 per cent in Q2. The labour market remained resilient P: Projection. albeit with some moderation. The composite PMI fell Note: India's data correspond to fiscal year (April-March); e.g., 2023 to a 29-month low of 49.0 in September from 50.6 in pertains to April 2023-March 2024. Sources: Official statistical agencies; Bloomberg; IMF WEO Update, July August amid contraction in both manufacturing and 2023. services sectors. The South African economy grew by The UK’s GDP grew by 0.8 per cent in Q2:2023 (q-o-q, 1.6 per cent (y-o-y) in Q2:2023 from 0.2 per cent in the saar) (1.3 per cent in Q1), supported by the extension previous quarter, with a rise in investment demand of an energy price guarantee by the government to and government expenditure. The composite PMI ease the cost of living, as well as fall in energy and for South Africa fell to 49.9 in September, indicating commodity prices. The labour market remains tight, stagnation after expanding for the first time in six notwithstanding an increase in the unemployment months in August. The Russian economy grew by rate to 4.3 per cent in May-July 2023, the highest 4.9 per cent (y-o-y) in Q2:2023 after four consecutive 80Chapter V External Environment quarters of contraction, with a recovery in domestic 2023 remained near its trend for several economies demand. The composite PMI posted 54.7 in September, (Chart V.1a). The global composite PMI fell to 50.5 with upturns in manufacturing and services output. in September, its lowest reading since January as the services PMI moderated sequentially. The In ASEAN3 economies, GDP growth was steady in manufacturing PMI downturn continued, despite a Q2:2023, buoyed by tourism as inflation moderated. marginal pick-up in September, as output, new orders The ASEAN manufacturing PMI slipped into and employment contracted (Chart V.1b). contraction territory for the first time in 25-months to Global merchandise trade volume declined by 1.7 49.6 in September from 51.0 in August, driven by the per cent (y-o-y) in Q2:2023 due to a slowdown in downturn in factory orders and decline in new export global economic activity, geopolitical tensions and business. geoeconomic fragmentation (Chart V.2a). It fell by Amongst high frequency indicators, the OECD 3.2 per cent in July, marking its steepest contraction composite leading indicators (CLIs) for September since August 2020. According to the WTO goods trade Table V.2: Select Macroeconomic Indicators for BRICS Real GDP growth Country 2022 2023(P) 2024(P) General Govt. Country 2022 2023(P) 2024(P) rate (Y-o-Y, per cent) gross debt (Per Brazil 2.9 2.1 1.2 cent of GDP) Brazil# 85.9 88.4 91.5 Russia -2.1 1.5 1.3 Russia 19.6 24.9 25.3 India 7.2 6.1 6.3 India 83.1 83.2 83.7 China 3.0 5.2 4.5 China 77.1 82.4 87.2 South Africa 1.9 0.3 1.7 South Africa 71.0 72.3 74.0 CPI inflation rate Country 2022 2023(P) 2024(P) Current account Country 2022 2023(P) 2024(P) (Y-o-Y, per cent) balance (Per cent Brazil 9.3 5.0 4.8 of GDP) Brazil -2.9 -2.7 -2.7 Russia 13.8 7.0 4.6 Russia 10.3 3.6 3.2 India 6.7 4.9 4.4 India -2.0 -2.2 -2.2 China 2.0 2.0 2.2 China 2.3 1.4 1.1 South Africa 6.9 5.8 4.8 South Africa -0.5 -2.3 -2.6 General Govt. net Country 2022 2023(P) 2024(P) Forex reserves* Country 2021 2022 2023 lending/borrowing (in US$ billion) (Per cent of GDP) Brazil -4.6 -8.8 -8.2 Brazil 362.2 324.7 344.2 Russia -2.2 -6.2 -2.8 Russia 630.6 582.0 581.7 India -9.6 -8.9 -8.3 India 633.6 562.7 590.7 China -7.5 -6.9 -6.4 China 3426.9 3306.5 3400.7 South Africa -4.5 -5.9 -6.1 South Africa 57.6 60.6 62.0 P: Projection. *: Forex reserves for 2023 pertain to August 2023 for all countries except for China (July 2023) and India (September 2023). #: Gross debt refers to the nonfinancial public sector, excluding Eletrobras and Petrobras, and includes sovereign debt held by the central bank. Notes: India's data correspond to fiscal year (April-March) except data on forex reserves which are as per calendar year. Sources: Official statistical agencies; WEO April 2023 database and July 2023 Update, IMF; Fiscal Monitor, April 2023, IMF; and International Reserve and Foreign Currency Liquidity (IRFCL), IMF, and RBI. 3 Association of Southeast Asian Nations (ASEAN) includes Brunei, Cambodia, Indonesia, Laos, Malaysia, Myanmar, Philippines, Singapore, Thailand and Vietnam. 81Monetary Policy Report October 2023 Chart V.1: Survey Indicators a: OECD CLI b: Composite PMI Note: For PMI indices a reading above 50 indicates an overall increase compared to the previous month, and below 50 an overall decrease. The indices are seasonally adjusted. Sources: OECD; and Bloomberg. barometer, the export orders component remains V.2 Commodity Prices and Inflation weak. In its July 2023 WEO update, the IMF projected Global commodity prices declined by 4.2 per cent (q-o-q) world trade (goods and services) growth to decelerate in Q2:2023 in terms of the Bloomberg commodity price from 5.2 per cent in 2022 to 2.0 per cent in 2023. index before rising from July 2023 onwards on higher Reflecting the subdued global trade outlook, the Baltic Dry Index (BDI), a benchmark of shipping costs of dry energy prices and the collapse of the Black Sea grain bulk, trailed its 2022 average (Chart V.2b). deal (Chart 3a). Global food prices, according to the Chart V.2: World Trade Volume a: World Trade Volume: Relative Contribution b: World Trade Volume and Baltic Dry Index Sources: CPB Netherlands; Refinitiv Eikon; and RBI staff estimates. 82Chapter V External Environment Food and Agriculture Organization (FAO), eased by 3.2 to the World Bank, natural gas prices softened by per cent (q-o-q) in Q2:2023 and a further 1.7 per cent 28.4 per cent in Q2 because of high inventories as in Q3 (up to August), primarily driven by a correction heating demand declined owing to a mild winter. in the prices of cereals and dairy products. Meat and The softening continued till July before prospects of sugar prices, which had hardened in Q2, softened in a strike at a liquefied natural gas producer in Australia Q3, while vegetable oil prices reversed the easing in intensified fears of disruption to global supplies in Q2 and rose in Q3 (Chart V.3b). August. Overall, natural gas prices edged up by 2.2 per cent in Q3 (Chart V.3c). Crude oil prices have firmed up since the last MPR. They initially softened during Q2, largely reflecting Base metal prices have generally remained stable weak global economic demand (Chart V.3c). Crude since April 2023 in view of weak economic activity in oil prices rose sharply in Q3 in response to cuts in China and sustained monetary tightening worldwide. oil supplies by Saudi Arabia and Russia that were Gold price rebounded in the first half of Q2 on safe extended through the rest of 2023. Brent crude prices haven demand amidst bank failures in the US and crossed US$ 90 per barrel in September, touching Europe. It fell in June as central banks’ purchases their highest level since November 2022. According slowed down and retail demand for gold moderated. Chart V.3: Commodity Prices a: Bloomberg Commodity Price Index b: Food Price Indices c: Energy and Crude Oil Prices d: Metal Price Indices Sources: FAO; World Bank; Bloomberg; and PPAC, Ministry of Petroleum & Natural Gas, GoI. 83Monetary Policy Report October 2023 Gold price declined further in August as the US of moderation is tardy (Box V.1). Core goods inflation dollar strengthened. In September, most base metals eased as demand and supply for consumer goods prices hardened on Chinese stimulus measures to moved into better balance. Services price inflation support the housing market through relaxation in remains strong, contributing to wage pressures. requirements for mortgage down payments and According to the IMF’s WEO July 2023 update, global interest rates (Chart V.3d). inflation is projected to moderate from an annual Consumer Price Inflation average of 8.7 per cent in 2022 to 6.8 per cent in 2023 and further to 5.2 per cent in 2024 but would Consumer price inflation is easing, reflecting remain above the pre-pandemic (2017-19) level of softening energy and food prices, improving supply 3.5 per cent. chains and tighter monetary policy. It is, however, ruling well above targets, especially in AEs (Table In the US, headline CPI inflation decelerated from 5.0 V.3). Core inflation is relatively sticky, and the pace per cent (y-o-y) in March 2023 to 3.0 per cent in June Table V.3: Consumer Price Inflation (Y-o-y, per cent) Country Inflation Target Q3:2022 Q4:2022 Q1:2023 Q2:2023 Jul-23 Aug-23 Sep-23 Advanced Economies Canada 2.0 ± 1.0 7.2 6.7 5.1 3.5 3.3 4.0 Euro area 2.0 9.3 10.0 8.0 6.2 5.3 5.2 4.3 Japan 2.0 2.7 3.8 3.5 3.3 3.1 3.1 South Korea 2.0 5.9 5.2 4.7 3.2 2.3 3.4 3.7 UK 2.0 10.0 10.8 10.2 8.4 6.8 6.7 US 2.0 8.3 7.1 5.8 4.0 3.2 3.7 (6.6) (5.9) (5.0) (3.9) (3.4) (3.5) Emerging Market Economies Brazil 3.25 ± 1.5 8.7 6.1 5.3 3.8 4.0 4.6 Russia 4.0 14.4 12.2 8.8 2.7 4.3 5.2 India 4.0 ± 2.0 7.0 6.1 6.2 4.6 7.4 6.8 China 2.7 1.8 1.3 0.1 -0.3 0.1 South Africa 3.0-6.0 7.6 7.4 7.0 6.2 4.7 4.8 Mexico 3.0 ± 1.0 8.5 8.0 7.5 5.7 4.8 4.6 Indonesia 3.0 ± 1.0 5.2 5.5 5.2 4.0 3.1 3.3 2.3 Philippines 3.0 ± 1.0 6.5 7.9 8.3 6.0 4.7 5.3 6.1 Thailand 1.0-3.0 7.3 5.8 3.9 1.1 0.4 0.9 0.3 Turkey 5.0 ± 2.0 81.1 78.1 54.5 40.5 47.8 58.9 61.5 Memo: 2021 2022 2023 (P) 2024 (P) World consumer price inflation 4.7 8.7 6.8 5.2 P: Projection. Notes: (1) Japan’s inflation pertains to CPI inflation in all items less fresh food – the Bank of Japan’s target measure. (2) Figures in the parentheses for US are year-on-year change in personal consumption expenditure (PCE) price index. Sources: Central bank websites; IMF, and Bloomberg. 84Chapter V External Environment Box V.1: Global Core and Headline Inflation Dynamics The combination of the surge in demand fuelled by Table V.1.1: Headline and Core Inflation: unprecedented monetary and fiscal stimulus and sustained Co-integration and Error Correction Estimates supply distortions and commodity price shocks caused by the pandemic and accentuated by the war in Ukraine Pre-COVID (January 2012- February 2020) triggered a flaring up of inflation, both headline and core, Variables Advanced Emerging Market Combined economies Economies (EMEs) across the world in 2021-2022 to multi-decade high levels. (AEs) While more recently inflation is easing, a sticky core and ∆Headline inflation its potential spillovers to headline inflation have emerged Long run equation: Headline inflation= β. Core inflation + error correction as the key policy concern. If headline inflation converges Core 0.99*** 0.93*** 0.94*** to core inflation, then increases in food and energy (21.45) (25.87) (31.83) inflation may not lead to a persistent rise in headline. By Short run contrast, if core inflation converges to headline, this would Error correction -0.12*** -0.10*** -0.11*** (-4.43) (-6.29) (-7.40) indicate second-round effects that can cause inflation ∆Core inflation expectations to rise, triggering appropriate responses from Long run equation: Core inflation= β. Headline inflation + error correction monetary policy makers (Cecchetti and Moessner, 2008). Headline 0.56*** 0.49*** 0.54*** (15.66) (12.01) (19.43) To explore these feedback mechanisms, a panel regression Short run for 26 economies (comprising both AEs and EMEs) for Error correction -0.10*** -0.06*** -0.08*** January 2012 to July 2023 is undertaken which indicates (-4.24) (-4.78) (-5.80) cointegration between core and headline inflation. Full Sample (January 2012- July 2023) Accordingly, a vector error correction model (VECM) ∆Headline inflation is estimated by using the pooled mean group (PMG) Long run equation: Headline inflation= β. Core inflation + error correction Core 1.01*** 0.81*** 0.86*** approach (Pesaran et al., 1999). The short-run dynamics (35.12) (29.59) (39.90) indicate that the coefficients of the error correction Short run terms in both the equations are negative and statistically Error correction -0.10*** -0.12*** -0.10*** (-3.53) (-3.77) (-5.61) significant. Thus, in the case of a shock, both core and ∆Core inflation headline inflation adjust, and the speed of adjustment in Long run equation: Core inflation= β. Headline inflation + error correction headline inflation towards core is somewhat higher than Headline 0.69*** 0.98*** 0.96*** in the core inflation equation4 (Table V.1.1). The potential (36.16) (25.18) (41.59) Short run two-way spillovers and the generalisation of inflation Error correction -0.09*** -0.08** -0.08*** risks can warrant priority in policy settings to contain (-7.49) (-2.91) (-4.48) them quickly, which vindicates the ‘higher for longer’ Note: Figure in parentheses are t-statistics. * p<0.05, ** p<0.01, *** p<0.001. stance going forward. Sources: RBI staff estimates. References: Cecchetti, Stephen G, and Richhild Moessner (2008), “Commodity Prices and Inflation Dynamics”, BIS Quarterly Review, pp. 55-66. Gamber, E. N., Smith, J. K., and Eftimoiu, R. (2015), “The Dynamic Relationship between Core and Headline inflation”, Journal of Economics and Business, Vol. 81, pp. 38-53. Liu, Z., and Weidner, J. (2011), “Does Headline Inflation Converge to Core?” FRBSF Economic Letter. Pesaran, M. Hashem, Yongcheol Shin, and Ron Smith (1999), “Pooled Mean Group Estimation of Dynamic Heterogeneous Panels”, Journal of the American Statistical Association, Vol. 94, pp. 621-634. 4 The results are broadly similar for the full sample and the pre-COVID sample. 85Monetary Policy Report October 2023 but then hardened to 3.7 per cent in August. Core CPI eased to 6.7 per cent in August 2023 from 10.1 per inflation eased from 5.6 per cent to 4.3 per cent during cent in March 2023 while core inflation at 6.2 per cent the same period. Inflation in terms of the personal in August was unchanged from its level in March. In consumption expenditure (PCE) price index – the US Japan, CPI inflation (all items less fresh food) was 3.1 Federal Reserve (Fed)’s preferred measure of inflation per cent in August 2023, the same level as in March, – moderated from 4.4 per cent in March to 3.5 per though core inflation (inflation excluding fresh food cent in August (Chart V.4a), while core PCE inflation and energy) edged up to 4.3 per cent in August from fell from 4.8 per cent to 3.9 per cent (Chart V.4b). 3.8 per cent in March 2023. In the Euro area, CPI inflation eased by 260 bps to Amongst major EMEs, CPI inflation in Brazil 4.3 per cent in September 2023 from 6.9 per cent in moderated during March-June 2023 but then edged up March. Core inflation (inflation excluding energy, to 4.6 per cent in August 2023 (Chart V.4c). In Russia, food, alcohol and tobacco) moderated by only 120 bps it rose to 5.2 per cent in August 2023 from 3.5 per to 4.5 per cent in September. In the UK, CPI inflation cent in March, partly due to currency depreciation. Chart V.4: CPI Inflation (y-o-y) – Select Economies a: Advanced Economies - Headline b: Advanced Economies - Core 12 10 8 6 4 2 0 -2 c: Emerging Market Economies - Headline d: Emerging Market Economies - Core Notes: 1. For India, core CPI, i.e., CPI excluding food and fuel is worked out by eliminating the groups ‘food and beverages’ and ‘fuel and light’ from the headline CPI. 2. Japan’s data in Chart V.4a refer to CPI inflation in all items less fresh food – the Bank of Japan’s target measure, while data in Chart V.4b refer to CPI inflation in all items less fresh food and energy. Sources: Official statistical agencies; and Bloomberg. 86 tnec reP 22-naJ 22-beF 22-raM 22-rpA 22-yaM 22-nuJ 22-luJ 22-guA 22-peS 22-tcO 22-voN 22-ceD 32-naJ 32-beF 32-raM 32-rpA 32-yaM 32-nuJ 32-luJ 32-guA 32-peS US (PCE) UK Euro Area Japan 19 15 11 7 3 -1 tnec reP 22-naJ 22-beF 22-raM 22-rpA 22-yaM 22-nuJ 22-luJ 22-guA 22-peS 22-tcO 22-voN 22-ceD 32-naJ 32-beF 32-raM 32-rpA 32-yaM 32-nuJ 32-luJ 32-guA Brazil Russia China Brazil Russia China SouthAfrica India SouthAfrica IndiaChapter V External Environment In South Africa, CPI inflation softened to 4.8 per 2023 meeting, it decided to discontinue reinvestments cent in August 2023 from 7.1 per cent in March. In under the Asset Purchase Programme (APP) from China, headline inflation remained subdued during July 2023 while continuing to reinvest the principal 2023 – it moderated from 0.7 per cent in March 2023 payments from maturing securities purchased under to 0.1 per cent in August (with a temporary descent the Pandemic Emergency Purchase Programme (PEPP) into deflation of 0.3 per cent in July), reflecting weak until at least the end of 2024. In its July meeting, demand. Core inflation across EMEs has generally the ECB reduced the remuneration of minimum remained stickier than headline inflation (Chart V.4d). reserves to zero per cent (the remuneration was at the deposit facility rate earlier). The Bank of England V.3 Monetary Policy Stance (BoE) raised its policy rate in its May 2023 meeting During Q2 and Q3 of 2023, major central banks across by 25 bps, followed by 50 bps in June and 25 bps in AEs and EMEs hiked their benchmark rates in steps August, taking the cumulative increase to 515 bps in of 25 bps or retained their policy rates at restrictive the current tightening cycle that started in December levels. A few central banks especially among EMEs 2021. The BoE maintained its policy rate at 5.25 per initiated an easing cycle in response to a softening cent in its September meeting while announcing an inflation trajectory. enhanced reduction of £100 billion in the stock of UK After initiating the tightening cycle in March 2022, the government bonds. US Fed raised the target range for the federal funds Amongst other major AEs, the Bank of Canada raised rate in all its subsequent policy meetings till May its policy rate by 25 bps each in its June and July 2023 2023 although it reduced the size of rate increase to meetings after a pause in the previous two meetings 25 bps from hikes of 50 and 75 bps in 2022. In its June (March and April 2023) – a cumulative hike of 475 2023 meeting, the Federal Open Market Committee bps in the current tightening cycle. It kept the rate (FOMC) decided to pause for the first time in over a unchanged in its September 2023 meeting. The Reserve year following a cumulative increase of 500 bps. In its Bank of Australia raised its cash rate target by 25 bps July meeting, the Fed raised the target range of the each in its May and June meetings while pausing in federal funds rate by 25 bps to 5.25-5.50 per cent, the July-September meetings. It has cumulatively taking it to its highest level in 22 years and maintained increased its policy rate by 400 bps since May 2022. the level in its September meeting (Chart V.5a). As per The Norges Bank and the Bank of Korea have raised the Summary of Economic Projections released in their policy rates by 375 bps and 250 bps, respectively, September 2023, the majority of FOMC participants since 2022 while the Central Bank of Iceland and the expected the federal funds rate to be in the range of Czech National Bank effected cumulative hikes of 5.5-5.75 per cent by end 2023 and 5.0-5.25 per cent 725 bps and 325 bps, respectively (Chart V.5a). On by end 2024, indicating further monetary tightening the other hand, the Bank of Japan (BoJ) remained this year and fewer rate cuts next year as compared to an outlier, maintaining an accommodative stance June projections. The US Fed also continued with its with the overnight interest rate on hold at minus 0.1 balance sheet reduction policy. per cent. The BoJ in its July 2023 meeting, however, The ECB increased its policy rate by 25 bps in each amended the conduct of yield curve control (YCC) to of its May-September 2023 meetings, cumulatively incorporate greater flexibility regarding the upper and increasing the benchmark rate by 450 bps. In its May lower bounds as references. It offered to purchase 10- 87Monetary Policy Report October 2023 Chart V.5: Policy Rate Changes – Select Major Economies a: Advanced Economies b: Emerging Market Economies Source: Bloomberg. year Japanese government bonds at 1.0 per cent every Bank of Russia (BoR) switched gears by commencing a business day through fixed-rate purchase operations, tightening cycle in July 2023, increasing the policy rate instead of the previous 0.5 per cent. by 100 bps to contain price stability risks, following it by increases of 350 bps in an off-cycle meeting Amongst the BRICS, the Banco Central do Brasil started in August and 100 bps in the September meeting, a rate cut cycle in August 2023 with a reduction of taking the policy rate to 13.0 per cent. Earlier, it had 50 bps after raising rates cumulatively by 1175 cumulatively cut the policy rate by 1250 bps between bps between March 2021 and August 2022. It was April-September 2022 and held it steady for the next 6 followed by another 50 bps cut in September 2023. meetings until June 2023 (Chart V.5b). The South African Reserve Bank continued with the tightening cycle and increased its policy rate by 50 Amongst Asian EMEs, the Bank of Thailand, which bps in its May 2023 meeting, cumulatively increasing embarked on the tightening cycle in August 2022, its benchmark rate by 475 bps before pausing in its raised the rate by 25 bps in all its subsequent meetings. July and September meetings. The People’s Bank of The Bank Indonesia maintained its policy rate at 5.75 China (PBoC) adopted an accommodative monetary per cent in all its meetings since February 2023. In policy stance, effecting its first cut in 10 months in Latin America, central banks of Mexico and Colombia the policy rates in June 2023. In August, it further held their policy rates constant in all meetings since reduced its 1-year Loan Prime Rate (LPR) and 7-day May 2023. On the other hand, Chile lowered its policy reverse repurchase agreements rate by 10 bps each rate by 175 bps to 9.5 per cent during July-September and the 1-year medium-term lending facility loans 2023, after hiking it by 1075 bps between July 2021 rate by 15 bps while maintaining the 5-year LPR at and October 2022. Peru cut its policy rate by 25 bps in 4.20 per cent. In September it reduced its reserve its September meeting after holding it steady for seven requirement ratio by 25 bps for all banks except those months. Among European EMEs, Poland embarked on that have implemented a 5 per cent reserve ratio. The a rate cutting cycle, lowering its policy rate by 75 bps 88Chapter V External Environment in its September meeting after keeping it on hold since economic data, optimism over the peaking of policy October 2022. The central bank of Turkey raised its rates and a rally in technology stocks. In August and policy rate by 2150 bps between June and September September, however, sentiment took a blow from the 2023, after cutting it cumulatively by 550 bps between rise in long-term bond yields and the hawkish tone August 2022 and February 2023. in minutes of the FOMC’s July meeting and FOMC's statement of September. Overall, the US S&P index V.4 Global Financial Markets rose by 4.3 per cent during April-September 2023. Global financial markets exhibited high flux during The European stock market underperformed, given Q2 and Q3, responding to changing expectations relatively weak economic data. The UK’s stock indices on the monetary policy trajectory. Markets turned declined in Q2 as consumer price inflation slowed less buoyant during April-July 2023 as prospects of hard than anticipated, but reversed the trend in Q3 with landing receded and hopes of an end to the monetary lower than expected inflation print. The Japanese tightening cycle in the US, earlier than expected, market outperformed its peers on continuation of gained ground. Financial markets corrected in Q3 on ultra-accommodative monetary policy by the BoJ. stronger data and 'higher for longer' monetary policy EME equities, barring China and South Africa in Q2, stances. Overall, bond yields have firmed up since the gained, tracking global cues and reaping benefits of an last MPR. The US dollar has remained volatile with a early commencement of the tightening cycle leading strengthening bias since August. The EME currencies to lower inflation prints (Chart V.6b). In Q3, however, broadly weakened since Q2:2023. EME equities barring Russia and India corrected Equity markets, in terms of MSCI world index, gained on tighter financial conditions globally and volatile 1.6 per cent since end March reflecting gains in AEs capital flows. Chinese stocks lost ground amidst the equity markets (Chart V.6a). Among AEs, US S&P 500 flagging economic recovery. Portfolio outflows exerted gained about 8 per cent in Q2:2023 supported by better downward pressures on equities. Chart V.6: Equity Markets a: Equity Indices (MSCI) b: Change in Equity Indices Sources: Bloomberg; and RBI staff estimates. 89Monetary Policy Report October 2023 Chart V.7: 10-Year Sovereign Bond Yields a: Select AEs b: Select EMEs Source: Bloomberg. Sovereign bond yields across major AEs hardened bps following modest inflation prints. In Q3:2023, in Q2:2023 and Q3, reflecting ongoing monetary Brazilian yield edged up marginally as investors tightening and the slow pace of disinflation. The reassessed the outlook on the Selic rate after July's US 10-year treasury yield rose by 37 bps during Q2 CPI print exceeded the central bank's target of 3.25 and rose further in Q3 to its highest level since 2007 per cent. following a hawkish policy stance, announcement of larger debt issuance by the US Treasury and the In the currency markets, the US dollar weakened in sovereign rating downgrade by Fitch Ratings. The April 2023 but strengthened in May on increased German 10-year bond yield broadly tracked the US safe haven demand amidst debt ceiling concerns and market while the UK 10-year yield hardened before uncertain global economic prospects (Chart V.8a). It moderating on a benign inflation print for July. The reversed the uptrend in June and July, falling to a 10-year Japanese Government bond yield hardened 15-month low on optimism about a policy pivot by by 36 bps during Q3 pushed up by the BoJ’s the Fed. Resilient US economic data and expectations incorporation of greater flexibility in its conduct of of rates staying higher for longer led to a stronger yield curve control (Chart V.7a). dollar in August-September. The US dollar’s volatility Bond yields in several EMEs exhibited a hardening was mirrored in the EME currencies, exacerbated bias, driven by domestic monetary tightening as well by swings in capital flows (Chart V.8b). The MSCI as global cues (Chart V.7b). Brazilian 10-year bond Emerging Market Currency Index declined by around yield softened in the second quarter of 2023 by 219 1 per cent in Q2:2023 and by 0.4 per cent in Q3. 90Chapter V External Environment Chart V.8: Currency Movements and Capital Flows a: Currency Indices b: Portfolio Flows to EMEs Sources: Bloomberg; and IIF. V.5 Conclusion the headline amidst strong labour markets. The uncertainty about the monetary policy trajectory Global growth is losing momentum, with downside is imparting volatility to global financial markets. risks to the outlook from stubborn core inflation, Swings in capital flows, volatile currency movements, tight financial conditions, high public debt, weak recovery in China, geopolitical tensions, geoeconomic elevated debt burden and tight financial conditions fragmentation and extreme weather events. Inflation pose sizeable downside risks to the outlook for EMEs, is easing unevenly across countries but rules above especially those with large external financing needs the target, especially in advanced economies. Core in an environment in which financial conditions are inflation is softening at a more moderate pace than tightening. 91