While the RBI may have articulated a ‘neutral’ stance which would leave it enough headroom to move either way depending on data, bond markets sold off after the announcement, anxious about the higher inflation forecasts.
With most banks having already upped their lending rates over the past week, the 25-basis-point increase in the key repo rate to 6.25% by the Reserve Bank of India (RBI) on Wednesday was merely more affirmation money is becoming costlier. For consumers — corporate and individual — loans are turning more expensive, unfortunate given the economic recovery is a very shallow one. The 7.7% year-on-year GDP growth in Q4FY18 was driven almost entire by government spending with the private sector playing only a small role.
While the RBI may have articulated a ‘neutral’ stance which would leave it enough headroom to move either way depending on data, bond markets sold off after the announcement, anxious about the higher inflation forecasts. The yield on the benchmark closed the session 7.92%, up 9 basis points over Tuesday’s closing, a three-year high. It was not clear why equity markets rallied since economists say more rate hikes are on the way and that can only harm corporate India already grappling with high raw material costs.
Sonal Varma, chief economist at Nomura India, believes both growth and inflation are likely to head higher in the coming months, paving the way for another 25-basis-point rate hike in August. “However, the ongoing tightening of financial conditions, higher oil prices and political uncertainty are likely to slow economic activity after September, in our view,” Varma noted.
The bond markets were also disappointed the RBI hadn’t been more reassuring on liquidity. DK Joshi, chief economist at Crisil, said that with somewhat tighter liquidity conditions in the banking system, rates on commercial paper borrowings have hardened nearly 90 basis points so far in 2018, and 40 basis points since the last policy. “Meanwhile, banks also have started raising their deposit and loan rates after a nearly four-year rate easing cycle,” Joshi pointed out.
RBI deputy governor Viral Acharya observed that higher-than-expected increase in the currency in circulation in both April and May as well as the RBI’s forex operations during the period had negated much of the system-wide increase in liquidity. “In other words, liquidity remained in the neutral zone during March and April, even though it switched back between deficit and liquidity during several weeks,” Acharya said. He added that government spending had driven up the liquidity surplus in June but said advance tax payments would suck out money from the system.
RBI governor Urjit Patel said a neutral stance leaves all options open, pointing out and other central banks also do the same. Patel explained there was no tension between a rate hike and maintaining a neutral stance, saying the monetary policy committee felt there were enough uncertainties to keep to the neutral stance and yet respond to the risks to the inflation target that have emerged in recent months.