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RBI fires a rate-hike bazooka: War on inflation sees surprise rate action; Repo rate up 40 bps, CRR 50 bps

“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.”

The move came a few hours ahead of the Federal Reserve’s rate decision on Wednesday (midnight India time), which is expected to see the US central bank’s most aggressive action to battle inflation in decades.
The move came a few hours ahead of the Federal Reserve’s rate decision on Wednesday (midnight India time), which is expected to see the US central bank’s most aggressive action to battle inflation in decades.

In a surprise move, the Reserve Bank of India (RBI) on Wednesday hiked the repo rate by 40 basis points (bps) to 4.4% and the cash reserve ratio (CRR) that banks must hold with the central bank by 50 bps to 4.5%.

The rate decision, taken at an out-of-turn meeting of the monetary policy committee (MPC) on May 2 and 4, shocked markets and pushed the benchmark 10-year bond yield to 7.42%, its highest levels in three years, right after the policy decision (it eventually closed at 7.38%). All members voted unanimously in favour of the rate hike in view of intensifying inflationary pressures.

The move came a few hours ahead of the Federal Reserve’s rate decision on Wednesday (midnight India time), which is expected to see the US central bank’s most aggressive action to battle inflation in decades.

Economists and market experts said they expect more rate hikes in the year ahead. While some said they foresee an additional 35-60 bps of rate hikes in the first half of this financial year, rating agency Crisil said it expects the RBI to hike the repo rate by another 75-100 basis points this fiscal.

The hike in CRR will result in liquidity worth Rs 87,000 crore being squeezed out of the market, forcing banks to price their loans higher. The revision in the repo will result in an immediate increase in rates on retail and small business loans linked to the benchmark.

With the revision in the policy rate, the policy corridor will now have the standing deposit facility at 4.15% as its floor and the marginal standing facility at 4.65% as its ceiling.

RBI governor Shaktikanta Das announced the changes in an afternoon statement where he said unambiguously that inflation is only headed upwards from the 6%-plus prints seen for the first three months of 2022.

He referred to spillovers from global wheat shortages impacting domestic prices, the possibility of edible oil prices firming up further and high feed costs leading to higher poultry, milk and dairy product prices as well as the impact of elevated crude prices on 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,” he said, adding that 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.”

Most analysts are estimating the April consumer inflation print to be higher than 7.5%.

Interestingly, the MPC reiterated its April policy stance that it shall remain accommodative with a focus on withdrawal of accommodation even as it raised the key policy rate for the first time since August 2018. Das drew a parallel between Wednesday’s out-of-cycle rate hike and the second of the MPC’s two unscheduled Covid-era rate cuts in May 2020, saying that the latest move marks an exit from pandemic-era ultra accommodative policy.

Markets were clearly surprised as most were expecting a 25 bps rate hike in the June policy. However, they saw the sudden rate hike as an extension of the RBI’s commitment to withdraw accommodation and as a reflection of its urgency to ensure inflationary pressures do not get unhinged. Aditi Nayar, chief economist, Icra, said, “By advancing the rate decision by approximately one month, the MPC has focused on preventing inflationary expectations from unanchoring in an increasingly uncertain environment.”

Economists also saw in the MPC action a move to protect the rupee from foreign fund outflows on the eve of the Fed meet. “The rate increase by the RBI puts in place a pre-emptive ‘traditional defence’ for the rupee against capital outflows as global monetary policy tightens,” Abheek Barua, chief economist, HDFC Bank, said.

In his statement, Das did offer his characteristic hat tip to growth and said that sustained high inflation hurts output and the purchasing power of the poorer segments of the population. “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,” he said.

The banking sector seemed to echo the governor’s sentiments and hailed the return of pricing power. Uday Kotak, MD & CEO, Kotak Mahindra Bank, applauded the RBI for moving to tame inflation. “It was pretty clear that the wolf of inflation is getting more entrenched and therefore, there was clearly a need to move,” Kotak said, adding “you cannot allow the wolf to get deep in because it then becomes that much tougher to get the wolf out”.

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