The Reserve Bank of India’s (RBI) rate-setting panel finally flipped over growth to make inflation its top priority at its latest policy meeting, signalling the end of an over two-year-long period of what deputy governor Michael Patra called “ultra accommodation”. Expressing concern around rising commodity prices due to the war in Ukraine, the central bank raised its forecast for inflation and lowered that for growth.

RBI governor Shaktikanta Das said in no uncertain terms that the time for a rejigging of priorities had come. “In the sequence of priorities we have now put inflation before growth. For the last three years starting February 2019, we had put growth ahead of inflation in the sequence. This time we have revised that because we thought that the time is appropriate and that is something which needs to be done,” he said.

While the monetary policy committee (MPC) voted unanimously to keep the stance accommodative, it inserted the rider that it will be “focusing on withdrawal of accommodation to ensure that inflation remains within the target going forward, while supporting growth.” As expected, the inflation projection for FY23 was hiked by more than a percentage point to 5.7% from 4.5%. The growth projection was slashed more sharply than expected — to 7.2% from 7.8%.

Key policy rates were left unchanged once again (the repo rate at 4% and the reverse repo rate at 3.35%), with a standing deposit facility (SDF) being introduced to act as the floor for the policy corridor at 3.75%. This will result in the policy corridor narrowing to 50 basis points (bps) from 65 bps.

Zarin Daruwala, cluster CEO, India and South Asia markets (Bangladesh, Nepal and Sri Lanka), Standard Chartered Bank, said that the decision to raise the operational rate by 40 bps by introducing the SDF window is in sync with rising inflation and higher global yields.

“With this move, the MPC has reaffirmed its commitment to containing inflation, while promising adequate liquidity to support India’s growth agenda. The move also will bolster macroeconomic stability and fortify the rupee,” she said.

Das attributed the hike in the inflation projection to war-induced factors, especially the recent trend of hardening in crude prices, which rose to $130 a barrel at one point. The MPC assumed a price of $100 per barrel for the purpose of its projections. A rise in prices of edible oil, wheat and animal feed, which feeds into prices of poultry, eggs and dairy products, were also factors that played into the revised inflation forecast.

Patra characterised the decision to hold the repo rate at an all-time low of 4% for a prolonged period of two years as a policy of ultra-accommodation applied specifically to deal with the shock of the pandemic. “Now that the situation is changing and inflation, particularly, is at risk, we want to withdraw the ultra accommodation, but we still have scope to remain accommodative,” Patra said.

Inflation measured by the consumer price index (CPI) overshot the upper end of the MPC’s tolerance band of 6% in January and February 2022, and may clock a 6%-plus print again in March, going by some estimates.

The April policy review turned out to be more hawkish than the expectations of the market, with the yield on the benchmark 10-year government security shooting up to to 7.12%, the highest since May 30, 2019, while the rupee strengthened six paise against the dollar to 75.90.
“This is clearly a hawkish policy as compared to the February meeting, justified by the inflationary pressures that have emerged over the past month,” said Abheek Barua, chief economist, HDFC Bank.

While the RBI did its bit to calm nerves by hiking the limit of government securities that can be held to maturity (HTM) to 23% from 22%, markets are hoping for a little more clarity on the nature of accommodation. According to Barua, despite the increase in HTM limits, bond yields are likely to rise, given the sheer size of the borrowing programme for FY23.

The absence of any statement on the yield curve being a public good was also construed by some as indication of the RBI’s willingness to let yields climb.
The commentary from the central bank has led to expectations of a policy rate hike as early as in August. “RBI no longer remains a stout dove and the reaction function is now evolving with fluid macro realities. The policy change in stance could formally change in the following policy, even as the RBI crawls gradually towards normalisation of liquidity,” said Madhavi Arora, lead economist, Emkay Global Financial Services.

At the same time, the governor did chip in with a footnote to the effect that all models are subject to change. Describing the dislocations brought on by the evolving geopolitical scenario as “tectonic shifts”, Das said, “The situation is dynamic and fast-changing and all our actions will be tailored accordingly.”