The Reserve Bank of India’s monetary policy committee on Wednesday, unexpectedly, raised the policy repo rate by 40 basis points with immediate effect, a decision Governor Shaktikanta Das said was warranted in the backdrop of an alarming rise in inflation globally.
Post Wednesday’s surprise hike, the repo rate (the rate at which RBI lends banks) will rise to 4.40 per cent from 4.0 per cent and will effectively signal an end to the low interest rate policy that the central bank had unleashed in 2020 when the Covid-19 pandemic had hit.
The RBI had slashed repo rate by 75 basis points on March 27, 2020 and further by 40 basis points on May 22, 2020. Wednesday’s repo rate hike can be seen as a reversal of this action.
Even as the repo rate was raised, RBI said the MPC would remain accommodative while focusing on withdrawal of accommodation to ensure that inflation remained within the target going forward, while supporting growth.
As a part of its move to withdraw its accommodative policies, the RBI also announced a 50 basis points hike in the cash reserve ratio (CRR, or the amount of cash that commercial banks need to maintain with RBI) to 4.50 per cent of net demand and time liabilities, effective from the fortnight beginning May 21, 2022. With this increase in CRR, the RBI hopes to withdraw liquidity to the order of Rs 87,000 crore.
“Globally, inflation is rising alarmingly and spreading fast. Geopolitical tensions are ratcheting up inflation to their highest levels in the last three to four decades in major economies while moderating external demand,” noted Governor Das setting out the rationale to raise the repo rate.
Since Russia invaded Ukraine, crude oil prices have gone up and have been trading around $100 a barrel. Ukraine is also a major exporter of sunflower oil. The conflict, coupled with Indonesia’s decision last month to ban exports of palm oil, have led to a surge in edible oil prices. A rise in prices of fertiliser and other input costs, too, will have a direct impact on food prices in India.
Furthermore, monetary policy normalisation in advanced economies, through interest rate hikes as well as unwinding of quantitative easing is expected to gain pace. These developments would have ominous implications for emerging economies, including India, said Das.
RBI’s rate action comes ahead of a meeting of the US Federal Reserve later on Wednesday. The Fed is expected to raise interest rates for the second time since 2018, some estimate the hike could be as much as 50 basis points.
Separately, Covid-19 related lockdowns in major production hubs is likely to accentuate global supply chain bottlenecks, while depressing growth. In this backdrop global growth projections have been revised downwards by up to 100 bps in 2022. These dynamics pose upside risks to India’s inflation trajectory set out in the MPC resolution of April 2022, according to Das.
“The MPC judged that the inflation outlook warrants an appropriate and timely response through resolute and calibrated steps to ensure that the second round effects of supply side shocks on the economy are contained and long-term inflation expectations are kept firmly anchored,” he said.
Driven by rising prices of fuel and food products, retail inflation in India touched 6.95 per cent in March, a 17-month high. The RBI MPC believes that food inflation pressures are likely to continue. In the April MPC meeting, RBI raised its retail inflation forecast for the current financial year to 5.7 per cent, from 4.5 per cent projected earlier. RBI’s objective is to maintain inflation in the 2 per cent to 6 per cent band.
“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,” said Das.
While inflation is rising, RBI also noted that domestic economic activity that had seen a rebound post ebbing of the Omicron wave of COVID19 was turning out to be increasingly broad-based.
Das feels Wednesday’s monetary policy actions aimed at lowering inflation and anchoring inflation expectations would strengthen and consolidate the medium-term growth prospects of the economy. At the same time, the MPC remained mindful of the possible near-term impact of higher interest rates on output and its actions therefore would be “calibrated,” it said.
“As several storms hit together, our actions today are important steps to steady the ship,” said Das.
RBI’s surprise repo rate action sent markets tumbling. The BSE Sensex declined 1,300 points or 2.3 per cent. The wider NIfty50 index also fell more than 2 per cent. On the other hand, benchmark 10-year bond yields jumped 28 basis points to around 7.4 per cent.
