In a surprise move, the monetary policy committee (MPC) of the Reserve Bank of India (RBI) has unanimously decided to increase the repo rate by 40 basis points (bps) to 4.40% with immediate effect. Consequently, the standing deposit facility (SDF) rate stands adjusted to 4.15% and the marginal standing facility (MSF) rate and the bank rate to 4.65%.
After an unscheduled rate review meeting of the MPC, RBI governor Shaktikanta Das says, "Sustained high inflation inevitably hurts savings, investment, competitiveness and output growth. It has pronounced adverse effects on the poorer segments of the population by eroding their purchasing power. I would, therefore, like to emphasise that our monetary policy actions today - aimed at lowering inflation and anchoring inflation expectations - will strengthen and consolidate the medium-term growth prospects of the economy."
"We remain mindful of the possible near-term impact of higher interest rates on output. Our actions will, therefore, be calibrated. I would like to further stress that monetary policy remains accommodative and our approach will be to focus on a careful and calibrated withdrawal of pandemic-related extraordinary accommodation, keeping in mind the inflation-growth dynamics. It is reiterated that the RBI will ensure adequate liquidity in the system to meet the productive requirements of the economy in support of credit offtake and growth," he says.
According to CRISIL Ratings, the sudden hike in policy rates by RBI seems to have been spurred by a sharp rise in inflation and growing risks to financial stability from US Federal Reserve's monetary policy tightening.
It says, "The monetary policy measures show the RBI's policy of gradual normalisation has come to an end. A sharp rise in inflation outlook for this fiscal year and an increasing pace of monetary policy tightening by major global central banks have significantly reduced the MPC's policy space. We expect the RBI to hike the repo rate by another 75-100 bps this fiscal. The hikes are likely to be frontloaded, given that inflationary pressures remain significantly high at present."
The MPC voted unanimously to increase policy repo rates by 40bps with immediate effect. The sharp acceleration in headline consumer price index (CPI) inflation in March 2022 to 7% was mainly propelled by food inflation.
According to Mr Das, the sharp acceleration in headline CPI inflation in March 2022 to 7% was propelled, in particular, by food inflation due to the impact of adverse spillovers from unprecedented high global food prices. "Nine out of the 12 food sub-groups registered an increase in inflation in March. High-frequency price indicators for April indicate the persistence of food price pressures. Simultaneously, the direct impact of the increases in domestic pump prices of petroleum products - beginning the second fortnight of March - is feeding into core inflation prints and is expected to have intensified in April."
RBI says in keeping with the stance of withdrawal of accommodation and in line with the earlier announcement of gradual withdrawal of liquidity over a multi-year time frame, it decided to increase the cash reserve ratio (CRR) by 50bps to 4.5% of net demand and time liabilities (NDTL), effective the fortnight beginning 21 May 2022. The withdrawal of liquidity through this increase in the CRR would be of the order of Rs87,000 crore.
Food Inflation Pressures Are Likely To Continue
Food price indices of the Food and Agriculture Organisation (FAO) and the World Bank touched historical highs in March and remain elevated.
According to the RBI governor, spillovers from global wheat shortages are impacting domestic prices, even though domestic supply remains comfortable. "Prices of edible oils may firm up further due to export restrictions by key producing countries and the loss of sunflower oil output due to the war. Elevated feed costs are translating into escalation in poultry, milk and dairy product prices. International crude oil prices continue to hover above US$100 per barrel and this is prompting pass through to domestic pump prices."
"The risks of unprecedented input cost pressures translating into yet another round of price increases for processed food, non-food manufactured products and services are now more potent than before. This could strengthen corporate pricing power if margins get squeezed inordinately. To sum up, the strengthening of inflationary impulses in sync with the persistence of adverse global price shocks poses upward risks to the inflation trajectory presented in the April MPC resolution," Mr Das says.
He further says, "The MPC judged that the inflation outlook warrants an appropriate and timely response through resolute and calibrated steps to ensure that the second-round effects of supply-side shocks on the economy are contained and long-term inflation expectations are kept firmly anchored. In the MPC's view, monetary policy response at this juncture would help to preserve macro-financial stability amidst increasing volatility in financial markets."
"Accordingly, the MPC decided to increase the policy repo rate by 40 bps in its meeting today; it also decided to remain accommodative while focusing on withdrawal of accommodation to ensure that inflation remains within the target going forward while supporting growth," he added.
As regards the outlook for domestic economic activity, the MPC says, the forecast of a normal southwest monsoon brightens the prospects for kharif production. "The recovery in contact-intensive services is expected to be sustained, with the ebbing of the third wave and the growing vaccination coverage. Investment activity should get an uplift from robust government capex, improving capacity utilisation, stronger corporate balance sheets and congenial financial conditions."
"On the other hand, the worsening external environment, elevated commodity prices and persistent supply bottlenecks pose formidable headwinds, along with volatility spillovers from monetary policy normalisation in advanced economies. On balance, the Indian economy appears capable of weathering the deterioration in geopolitical conditions but it is prudent to continuously monitor the balance of risks," the MPC says.
All members of the MPC, including Dr Shashanka Bhide, Dr Ashima Goyal, Prof Jayanth R Varma, Dr Rajiv Ranjan, Dr Michael Debabrata Patra and Shaktikanta Das, unanimously voted to increase the policy repo rate by 40bps to 4.4%.
According to the RBI governor, India's external sector has remained resilient amidst formidable global headwinds. Provisional data suggest that India's merchandise exports remained strong in April 2022 and services exports reached a new high in March 2022.
Due to geopolitical conditions and recent trade agreements, potential market opportunities have opened up, he says. "Strong revenue guidance by major information technology (IT) companies also bodes well for the overall external sector outlook in 2022-23. The worsening of terms of trade, driven by higher commodity prices, could have implications for the current account deficit in 2022-23, but it is expected to be comfortably financed. Net foreign direct investment flows have remained robust, despite some recent moderation. Long term flows such as external commercial borrowings also remain stable."
India's foreign exchange reserves are sizeable, with net forward assets providing a strong backup. The external debt to GDP ratio remains low at 20%.
Overall, the repo rate hike was expected, as inflation has definitely moved into the threatening zone, says Anuj Puri, chairman of ANAROCK group. "Unfortunately, for home buyers, this hike signals an imminent end to the all-time low-interest regime, which has been one of the major drivers behind home sales across the country since the pandemic began. This rise in interest rates will ultimately impact overall acquisition cost for homebuyers - and may dampen residential sales to some extent."
Umesh Revankar, vice chairman and managing director (MD) of Shriram Transport Finance, says, "We had expected the RBI to hike rates from the second half of the fiscal and hence the timing and quantum of RBI repo rate hike by 40bps and hike CRR by 50bps mid-cycle was a bit of surprise."
"We believe that the lending rates may go up gradually, and since there is enough liquidity in the system, our borrowing cost may go up only gradually. Most of the borrowing for us is fixed in nature and hence the rate hike will not have an immediate impact on borrowing costs. I still believe that the economy is recovering and growing, and I do not think a 40bps rate hike will dampen demand," he added.