Repo rate tops pre-Covid level

The RBI’s signal dispels a notion gaining currency that central banks everywhere may be nearing the end of their tightening cycle.

Repo rate tops pre-Covid level
RBI governor Shaktikanta Das said that inflation remains “unacceptably high”.

The monetary policy committee (MPC) of the Reserve Bank of India (RBI) voted unanimously to raise the repo rate by 50 basis points (bps) to 5.40%, above the pre-pandemic level of 5.15%. The third increase in a row signals the MPC’s intent to keep fighting inflation even as consumer prices show signs of easing.

The MPC said it would remain focused on withdrawal of accommodation to ensure that inflation remains within the target going forward, while supporting growth. External member Jayanth R Varma expressed reservations with this part of the resolution.

The Standing Deposit Facility rate and the Marginal Standing Facility Rate were adjusted higher by the same quantum to 5.15% and 5.65%, respectively.

Also Read: What RBI MPC’s 50bps repo rate hike means: Inflation to stay above comfort zone; another 50bps hike on cards?

The RBI joined central banks around the world, which have of late opted for large rate hikes in a bid to tame inflation, in delivering a hike that was at the higher end of market expectations. RBI governor Shaktikanta Das said that inflation remains “unacceptably high”. “If you look all around, other central banks today, 50 basis points (of rate hikes) has become the new normal and quite a number of central banks are now hiking by 75-100 (bps),” Das said, adding, “But then, in the Reserve Bank, we take a very calibrated and measured view.”

While stating that food and metal prices have been softening of late, the MPC cited persisting supply chain issues, a shortfall in paddy sowing and the transmission of high input costs into finished goods as risks to inflation. The rate-setting panel retained the inflation projection for FY23 at 6.7%, with Q2 at 7.1%, Q3 at 6.4% and Q4 at 5.8%. CPI inflation for Q1FY24 was projected at 5%, assuming a normal monsoon in 2022 and an average crude price of $105 per barrel.

The MPC resolution took note of an improvement in growth indicators such as capacity utilisation, credit growth and purchasing managers’ indexes (PMIs) to retain the real gross domestic product (GDP) growth projection for FY23 at 7.2%, with Q1 at 16.2%, Q2 at 6.2%, Q3 at 4.1% and Q4 at 4%. Real GDP growth for Q1FY24 was projected at 6.7%.

The RBI’s signal dispels a notion gaining currency that central banks everywhere may be nearing the end of their tightening cycle. With inflation staying elevated more rate hikes are all but inevitable in coming months, economists said.

Also Read | Repo Rate Hike: How will homebuyers get impacted and what should they do?

Dinesh Khara, chairman, State Bank of India (SBI), said the policy statement reaffirmed the RBI’s commitment to bring inflation down further and ensure financial stability in the markets. “In principle, the RBI from its vantage position has harmonised key measures, ensuring the economy remains cushioned to the maximum extent from the impact of inflation in everyday lives, he said.

Pranjul Bhandari, chief India economist, HSBC, observed that taking together the RBI’s inflation forecast of 5% for Q1FY24 and its earlier mention of real neutral rates at about one%, the repo rate “can be raised to 6%”. Bhandari expects rate hikes in the two remaining meetings for the year, taking the repo to 6% by December.

Experts, too, lauded the RBI’s decision to stick to its focus on inflation. Dharmakirti Joshi, chief economist, Crisil, said “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.” Inflation as measured by the consumer price index (CPI) eased to 7.01% in June from 7.04% in May, while holding well above the MPC’s target band of 2-6%.

In a departure from standard practice, the governor’s statement took note of India’s external balances, in addition to acknowledging that a weak rupee was adding to inflationary pressures. Export of goods and services together with remittances are expected to keep the current account deficit (CAD) within sustainable limits, Das said, while declining to share an estimate for India’s CAD for FY23.

Crisil’s Joshi said that Friday’s rate hike, although aimed at inflation, also partly addresses spillover risks from an aggressive stance of the US Federal Reserve and other systemically important central banks.

Surplus liquidity in the banking system moderated to Rs 3.8 trillion during June-July from Rs 6.7 trillion during April-May, Das said. Going forward, the RBI will conduct two-way fine-tuning operations as and when warranted – both variable rate repo (VRR) and variable rate reverse repo (VRRR) operations of different tenors, depending on the evolving liquidity and financial conditions.

The policy announcement was followed by a hardening in bond yields as the quantum of the rate hike was higher than the expectations of some sections of the market. The yield on the benchmark 10-year government bond rose to 7.3% from the previous day’s close of 7.157%.

Abheek Barua, chief economist and executive vice president, HDFC Bank, said he expects the RBI to take the repo to 5.75% by the end of the year. “The bond market rally seen over the last few days is likely to reverse and we expect the 10-year paper to trade closer to 7.3-7.4% by the end of the quarter as markets reprice in RBI action and the supply of both SDL (state development loans) and central government bonds this year,” Barua said.

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