RBI joins global central banks, more hikes to follow

As widely expected, the Reserve Bank of India (RBI) on Wednesday raised its policy rate by half a percentage point to 4.9 per cent — part of a series of rate hikes that will follow to fight high inflation in Asia’s third-largest economy. This is the second rate hike since May 4, when the Indian central bank had raised its policy rate by 40 basis points (bps), from 4 per cent, its lowest ever. One basis point is a hundredth of a percentage point.

For sure, it will follow up Wednesday’s action in August as well as September and, probably even in December, and continue to raise the policy rate before taking a breather. (The bi-monthly October meeting of the Monetary Policy Committee, the rate-setting body the RBI, has been advanced to September-end).

After experimenting with different instruments — first introducing variable reverse repo auctions and then replacing reverse repo rate with standing deposit facility (SDF) — the Indian central bank has now gone back to the familiar script, in line with the global central banks.

When will it stop raising rates and take a pause is anybody’s guess now.  Probably we will see the repo rate at 5.75 or 5.5 per cent by December. The overnight index swap (OIS) rates, a measure of market expectations on the money market rates, continue to price in over 7 per cent repo rate by June 2023. The 10-year bond yield closed at 7.49 per cent on Wednesday, from 7.52 per cent the previous day, as the market has priced in the rate hike.

While the hike in the repo rate is in sync with expectations, the rise in RBI’s inflation projection for current financial year is rather aggressive. It is 6.7 per cent, 70 bps higher than the upper band of the RBI’s inflation target (4 per cent +/- 2 percentage point). The central bank has, however, left its projection of GDP growth for FY23 unchanged at 7.2 per cent.

In February, it had estimated just 4.5 per cent average inflation for FY23. The Russia-Ukraine war and its impact on the oil price, among other things, forced it to raise the estimate to 5.7 per cent in April. Now, it has been raised to 6.7 per cent, based on assumptions of a normal monsoon and average crude oil price for the Indian basket at $105 per barrel.

Until May when the retail inflation surged to an eight-year high of 7.79 per cent, it was above the upper limit of the central bank’s flexible inflation target band for four months in a row.

The governor’s statement has pointed out that the upside risks to inflation, highlighted in April and May, have materialised earlier than anticipated — both in terms of timing and magnitude. Inflationary pressures have become broad-based and remain largely driven by adverse supply shocks and it is likely to remain above the upper tolerance band of 6 per cent through the first three quarters of FY23. This makes us believe that the RBI will not take a pause before raising the repo rate to 5.75-5.5 per cent and finally may stop at 6 per cent.

In his post-policy interaction with the media, RBI governor Shaktikanta Das said the policy rate is still below the pre-Covid pandemic level and the liquidity in the system is higher than what it was before the pandemic. The policy rate was 5.15 per cent before the pandemic. In August, the RBI will probably raise the rate beyond 5.15 per cent and follow it up with more rate hikes at the next two MPC meetings.

It is confident about growth but its concerns for inflation are palpable. The policy priority is controlling inflation, without losing sight of the growth requirements. The RBI is no longer following an “accommodative” stance; instead the focus is on “withdrawal of accommodation” and moving towards normal monetary conditions in a “calibrated manner”.

The repo rate is the rate at which commercial banks borrow money from the central bank; they park their excess liquidity with the RBI at SDF. With the hike in reverse repo rate to 4.9 per cent, SDF has been raised to 4.65 per cent and the marginal standing facility, or MSF, a window for commercial banks to access short-term money from the central bank, to 5.15 per cent. The overnight call money is expected to be priced between 4.65 per cent and 5.15 per cent, the 50 bps liquidity corridor, depending on the amount of excess liquidity.

Even though surplus liquidity at Rs 5.5 trillion between May 4 and May 31 was lower than Rs 7.4 trillion during April 8-May 3, it needs to shrink further as the overnight money market rates, on an average, have been trading below the policy repo rate.

The RBI has refrained from hiking banks’ cash reserve ratio (CRR) this time, after raising it by 50 basis points last month, sucking out Rs 87,000 crore. CRR is the portion of deposits that banks are required to keep with the RBI on which they don’t earn any interest. Will there be a hike in CRR in coming months? It’s difficult to say at this point but one cannot rule it out entirely as there are too much of uncertainties all around.

The writer, a consulting editor with Business Standard, is an author and senior adviser to Jana Small Finance Bank Ltd 

His latest book: Pandemonium: The Great Indian Banking Story 

To read his previous columns, please log on to https://bankerstrust.in 

Twitter: @TamalBandyo