By Deepak Jasani
At a time when domestic investors were watchful of US Fed rate hike and its future course, RBI went ahead and announced an unscheduled repo rate hike of 40bps to 4.4%. Consequently, the standing deposit facility (SDF) rate is adjusted to 4.15% and the marginal standing facility (MSF) rate and the Bank Rate to 4.65%. Apart from the timing of the announcement, what caught the market off-guard was a 40bps hike instead of 25bps rate hike as expected in its upcoming June meeting. Although April 2022 meet minutes reaffirmed MPC moving to address inflation related concerns emanating from global factors; inter-policy meeting rate action was not expected. In their April meeting, MPC members, unlike in the previous meeting, seemed less fixated on whether inflation is due to demand or supply side concerns; but rather indicated their view that inflation is high enough to warrant a monetary policy action.
CPI inflation surged to 6.95% (17-month high) in Mar’22 as compared to 6.07% in Feb’22 mainly on account of food price inflation; pushing headline inflation above RBI’s upper tolerance band for the third straight month. Apart from food prices, other components which registered high inflation include personal care and effects, and clothing and footwear. Core inflation (which excludes volatile components such as food and energy prices) has remained sticky at around 6% in FY22. The persistent supply disruptions and cost pressures have intensified globally amid the ongoing Russia-Ukraine tussle, contributing to the build-up of price pressures in the Indian economy.
There is the collateral risk of inflation remaining elevated at these levels for too long; as sustained high inflation inevitably hurts savings, investment, competitiveness and output growth. It has pronounced adverse effects on the poorer segments (especially food inflation) of the population by eroding their purchasing power. The MPC acknowledged that the risks to the near-term inflation outlook are rapidly materializing; it also pointed out that the April Inflation print (HDFC Bank estimates -7.6%) is expected to be elevated. To anchor inflation expectations and contain second round effects, MPC announced this surprise rate hike.
With normalisation of monetary policy in major advanced economies gathering pace – both in terms of rate increases and unwinding of quantitative easing as well as rollout of quantitative tightening; yesterdays’ announcement addresses certain market participants’ concerns of RBI being behind the curve in normalizing the policy. Immediately on the announcement, all interest rate sensitive stocks fell sharply including Banks, Auto, Real estate etc. The 10 year Gsec yields jumped 18bps from 7.20% to 7.38%. Rates across the yield curve are repriced factoring a more hawkish RBI. Yesterday’s move would help in pushing up real rates towards neutral over the next few quarters, as inflation is unlikely to soften soon and at a good pace. We believe, the RBI will not like the G-sec yields to move above 7.75% and use unconventional policy measures to ensure this.
Apart from repo rate hike, CRR hike was a bigger surprise. The Governor announced an increase in the cash reserve ratio (CRR) by 50bps to 4.5% of net demand and time liabilities (NDTL), withdrawing Rs 87,000cr from the system. RBI has moved to the path of gradual increase of policy interest rate and phased withdrawal of liquidity. The Governor, in his speech, highlighted the need to focus on the withdrawal of accommodation. He further added that yesterday’s decision of a 40bps hike is a reversal of policy reduction announced on May 22, 2020. Perhaps the Governor is indicating that a further 75bps hike is on cards (pre-covid policy rate was 5.15%).
The MPC continued to remain accommodative while focusing on withdrawal of accommodation to ensure that inflation remains within the target going forward, while supporting growth. Yesterday’s surprise announcement reflects RBI’s focus on a careful and calibrated withdrawal of pandemic-related extraordinary accommodation, while ensuring growth-inflation dynamics are maintained. We expect a further 25-50 bps rate hike in FY23.
(Deepak Jasani, Head of Retail Research, HDFC Securities. Views expressed are the author’s own.)