The Reserve Bank of India’s (RBI’S) monetary policy committee (MPC) voted to hike the repo rate by 50 basis points (bps) to 5.9% on Friday in its fourth such move in a row, continuing the fight against inflation and remaining focused on withdrawal of accommodation.
The rate-setting panel kept the inflation forecast for the year unchanged at 6.7%, with the central bank reiterating that inflation will likely cool off to 5% in Q1FY24.
RBI governor Shaktikanta Das did sound a note of caution on inflationary pressures that could emerge in the days ahead, even as crude prices show signs of easing. “Consumer price inflation remains elevated and above the upper tolerance band of the target due to large adverse supply shocks, some firming up of domestic demand and the spillovers from global financial markets,” Das said, adding that the recent correction in global commodity prices, including crude oil, if sustained, may ease cost pressures in the coming months.
“The inflation trajectory remains clouded with uncertainties arising from continuing geopolitical tensions and nervous global financial market sentiments,” Das said. Consumer price index (CPI) inflation spiked to 7% in August, well over the MPC’s target band of 4% +/- 2%, after trending down for three straight months.
The panel also cut its gross domestic product (GDP) growth forecast for FY23 to 7% from 7.2%, with Q2 at 6.3%, Q3 at 4.6% and Q4 at 4.6%.
Das was more upbeat on India’s growth prospects. High frequency data for Q2 indicate that economic activity remains resilient and private consumption has been holding up, he said. The RBI is betting on “unfettered” post-pandemic celebration of festivals to support a revival in urban demand. Rural demand is gaining gradually, Das said, and so is investment demand, evident from the robust growth of domestic production and import of capital goods in July and August.
Zarin Daruwala, cluster CEO, India and South Asia markets, Standard Chartered Bank, said the MPC’s decision to raise rates by 50 bps will help manage the growth and inflation dynamic. “Faced with heightened economic & geopolitical uncertainty and exceptionally volatile global markets, the RBI’s approach of gradualism is welcome,” she said.
While the quantum of the hike and the central commentary were broadly along expected lines, sections of the market were taken aback by the unchanged stance of monetary policy. A report by HDFC Bank’s treasury desk said, “The central bank did little to remove the ambiguity and perceived deviation around its stance, keeping it unchanged at withdrawal of accommodation, contrary to our expectations that a move to neutral was on the cards.”
Das said that liquidity conditions remain in the surplus mode – standing at about `5 trillion – and the nominal policy rate continues to trail inflation. He pointed out that this contrasts with 2019, when the stance was last neutral, as then liquidity was in deficit and the policy rate was higher than inflation. The RBI declined offering any forward guidance on the stance, stating only that inflation will come closer to the target over a two-year period.
Market participants saw the influence of the US Federal Reserve’s aggressive rate actions in Friday’s policy announcement. Rajeev Radhakrishnan, CIO-fixed income, SBI Mutual Fund, said, “The impact of external monetary tightening measures and its spillover effects have been evident in the policy stance and action today. To the extent that these factors prevail over the coming months, the terminal policy rate expectation locally could reset a bit higher.”
Das repeated the RBI’s line that currency market interventions are aimed solely at stemming volatility and the central bank does not target a particular level for the rupee. The future trajectory of monetary policy will be guided by incoming data and the evolving macroeconomic situation, he added.
Prakash Agarwal, director & head – financial institutions, India Ratings and Research, said the rate increase by the RBI will further aid margins of banks, given that around 47% of all floating-rate lending is linked to external benchmarks. “While bank deposit rates are likely to increase faster in the rest of the financial year than first half as system liquidity tightens and wholesale deposit rates trend higher, the rise still is likely to be calibrated, lagged and lower than repo,” he said.