INDIA: At a time when domestic investors were watching the US Federal Reserve’s rate hike and its implications for the future, the Reserve Bank of India (RBI) announced an unannounced repo rate hike of 40 basis points to 4.4 percent.
As a result, the standing deposit facility (SDF) rate has been adjusted to 4.15 percent. In comparison, the marginal standing facility (MSF) rate has been adjusted to 4.65 percent, and the Bank Rate has been adjusted to 4.65 percent.
Aside from the announcement’s timing, the market was taken aback by the fact that the rate hike was 40 basis points rather than the 25 basis points projected at the June meeting. Although the April 2022 meeting minutes underlined the MPC’s commitment to addressing inflationary concerns arising from global causes, no rate action was envisaged at the inter-policy meeting.
Unlike the previous meeting, MPC members seemed less concerned about whether demand or supply problems in April caused inflation. Instead, they expressed their belief that inflation is high enough to necessitate monetary policy action.
CPI inflation soared to 6.95 percent in March, up from 6.07 percent in February, owing primarily to food price inflation, pushing headline inflation above the RBI’s upper tolerance zone for the third month.
Aside from food prices, additional high-inflation components include personal care and effects and apparel and footwear. In FY22, core inflation (which eliminates volatile components like food and energy prices) remained stable at roughly 6%.
The ongoing Russia-Ukraine spat has exacerbated supply disruptions and pricing constraints worldwide, leading to the build-up of price pressures in the Indian economy.
There is a risk that inflation may persist at these levels for an extended period, as sustained high inflation will harm savings, investment, competitiveness, and economic growth. It has a significant negative impact on the poorer elements of the population (particularly food inflation) by reducing their purchasing power.
The MPC acknowledged that risks to the near-term inflation outlook are rapidly materialising and that the April inflation print (HDFC Bank estimates -7.6%) is expected to be elevated. The MPC announced this surprise rate hike to underpin inflation expectations and limit second-round consequences.
With the normalization of monetary policy in major advanced economies picking up steam – both in terms of rate hikes and the unwinding of quantitative easing and the rollout of quantitative tightening – yesterday’s announcement allayed market concerns that the RBI was behind the curve in normalizing policy.
All interest rate-sensitive stocks, such as banks, automobiles, and real estate, sank dramatically after the announcement. The 10-year Gsec yield increased 18 basis points to 7.38 percent. Rates are being repriced throughout the yield curve to account for a more hawkish RBI.
Inflation is unlikely to soften quickly and at a reasonable rate. Yesterday’s move will aid in pushing actual rates up towards neutral over the next few quarters. We anticipate that the RBI will deploy unorthodox policy measures to guarantee that G-sec yields will not rise above 7.75 percent.
The CRR increase was a bigger shock, apart from the repo rate increase.
The Governor announced a 50 basis point increase in the cash reserve ratio (CRR) to 4.5 percent of net demand and time liabilities (NDTL) and Rs 87,000 crore withdrawal from the system. The Reserve Bank of India has begun a steady hike in the policy interest rate and a phased drawdown of liquidity.
In his remarks, the Governor emphasized the importance of focusing on removing accommodations. He went on to say that the 40-bps raise announced yesterday is a reversal of the policy reduction announced on May 22, 2020. Perhaps the Governor is hinting at another 75 basis point raise (the pre-covid policy rate was 5.15 percent ).
The MPC maintained its accommodative stance while focused on removing accommodation to ensure that inflation remains within the target range while sustaining growth in the future.
The RBI’s surprising statement underlines the central bank’s focus on gradually withdrawing pandemic-related exceptional accommodation while maintaining growth-inflation dynamics. In FY23, we forecast another rate hike of 25-50 basis points.