RBI Hikes Repo Rate by 50bps to 5.40%; Expects Inflation To Remain at 6% during FY23
Moneylife Digital Team 05 August 2022

As expected, the monetary policy committee (MPC) of the Reserve Bank of India (RBI) has decided to increase the repo rate by 50bps (basis points) to 5.40%. Consequently, the standing deposit facility (SDF) rate stands adjusted to 5.15% and the marginal standing facility (MSF) rate and the bank rate to 5.65%.

In a statement, Shaktikanta Das, governor of RBI, says, "Headline inflation has recently flattened, and the supply outlook is improving, helped by some easing of global supply constraints. The MPC, however, noted that inflation is projected to remain above the upper tolerance level of 6% through the first three quarters of 2022-23, entailing the risk of destabilising inflation expectations and triggering second-round effects. Given the elevated level of inflation and resilience in domestic economic activity, the MPC took the view that further calibrated monetary policy action is needed to contain inflationary pressures, pull back headline inflation within the tolerance band closer to the target, and keep inflation expectations anchored so as to ensure that growth is sustained."

The MPC also decided to remain focused on the withdrawal of accommodation to ensure that inflation remains within the target, going forward, while supporting growth.

During May-June 2022, consumer price index (CPI) inflation eased to 7.0% from 7.8% in April, although it persists above the upper tolerance band. Food inflation has registered some moderation, especially with the softening of edible oil prices and deepening deflation in pulses and eggs.

According to RBI, fuel inflation moved back to double digits in June primarily due to the rise in LPG and kerosene prices. "While core inflation (i.e., CPI excluding food and fuel) moderated in May-June due to the full direct impact of the cut in excise duties on petrol and diesel pump prices, effected on 22 May 2022, it remains at elevated levels," it noted.

Mr Das says, "The inflation trajectory is now poised at a decisive point. While there are incipient signs of a confluence of factors that could lead to further softening of domestic inflationary pressures, there remain significant uncertainties. In such a milieu, with growth momentum expected to be resilient despite headwinds from the external sector, monetary policy should persevere further in its stance of withdrawal of accommodation to ensure that inflation moves close to the target of 4.0% over the medium term while supporting growth. A calibrated approach would provide sufficient flexibility to monetary policy in the current uncertain environment."

The introduction of SDF in April 2022, which raised the floor of the liquidity adjustment facility (LAF) corridor by 40bps, along with the policy repo rate hikes of May and June, have effectively resulted in the withdrawal of accommodation by 130bps.

"Consequently, the weighted average call rate (WACR) - the operating target of monetary policy - has commensurately firmed up. At the longer end of the money market, interest rates on 91-day treasury bills, commercial paper (CPs) and certificates of deposit (CDs) have also moved higher since April. The rate hikes also triggered an upward adjustment in the benchmark lending rates by the banks. Term deposit rates are also increasing, which should bode well for the availability of funds with the banks in the context of sustained buoyancy in credit demand," Mr Das says.

Dharmakirti Joshi, chief economist of CRISIL Ltd, feels that the frontloading of the repo rate hike was needed as inflation, despite some softening, is still way above the upper tolerance limit and monetary policy impacts it with a lag.

He says, "Generalised inflationary pressures and risks and uncertainty on the global front meant that the RBI could not lower its guard. We retain our growth and inflation outlook for this fiscal at 7.3% and 6.8%, respectively, and expect the MPC to raise the repo rate by another 25bps during its September review meeting.  Beyond that, actions will be guided by incoming data."

According to the central bank, surplus liquidity in the banking system, as reflected in average daily absorptions under the LAF, both SDF and variable rate reverse repo auctions, moderated to Rs3.8 lakh crore during June-July 2022 from Rs6.7 lakh crore during April-May. "The sharp moderation in surplus liquidity from 20th July, mainly on account of tax and capital outflows, resulted in money market rates firming up above the repo rate."

The RBI governor says the Indian economy has been impacted by the global economic situation. "We have been grappling with the problem of high inflation. Financial markets have remained uneasy despite intermittent corrections. We have witnessed large portfolio outflows to the tune of US$13.3 billion during the current financial year up to 3rd August," he says.

Overall system liquidity continues in surplus, with average daily absorption under the LAF at Rs3.8 lakh crore during June-July. Money supply (M3) and bank credit from commercial banks rose by 7.9% and 14.0%, respectively, as of 15 July 2022. India's foreign exchange reserves were placed at US$573.9 billion as of 29 July 2022, RBI says.

Reacting to the rate hike, Anuj Puri, chairman of ANAROCK group, says, "A rate hike was expected, but the expectation was for a maximum of 35bps. The hike by 50bps is definitely on the higher side, and home loan lending rates will now edge further into the red zone."

"This is the third consecutive rate hike in the last two months and finally marks the end of the all-time best low-interest rates regime - one of the major factors that drove housing sales across the country since the pandemic. This whammy comes along with the inflationary trends of primary raw materials, including cement, steel, labour, etc., that have recently led to a rise in property prices. Together, these factors - rising home loan rates and construction costs - will impact residential sales," he added.

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