Inflation is rising globally, driven by supply shortages caused by Covid-19 and rising food and oil prices due to the Russian invasion of Ukraine. In this backdrop, interest rates are expected to harden as central banks globally reverse their aggressive pandemic-era stimulus measures.
While the Reserve Bank of India had remained accommodative, many had expected it too would also reverse its stance and in all probability start raising interest rates from the June Monetary Policy Committee meeting. But, it sprang a surprise by announcing a 40 basis points repo rate hike in an unscheduled MPC meeting on May 4. Apart from raising the repo rate to 4.40 per cent, it also raised the cash reserve ratio (CRR), which is the amount of cash commercial banks need to maintain with RBI, by 50 bps.
With retail inflation soaring to an eight-year high of 7.79 per cent, analysts expect another repo rate hike coming in June, as the central bank may now have to accelerate monetary policy tightening.
“Lingering war between Russia and Ukraine, unprecedented level of sanctions, elevated oil and commodity prices, along with prolonged supply chain disruptions, have escalated the inflationary concerns both in global as well as domestic economies,” said Suman Chowdhury, chief analytical officer at Acuite Ratings.
The depreciating rupee—it hit a record of around 77.58 to a dollar this week—will also weigh on RBI’s moves.
RBI’s mandate is to rein in inflation at around 4 per cent in the range of 2-6 per cent. For the fourth consecutive month now, it has stayed above the upper tolerance band.
A major reason behind the inflation spike in April is food inflation, which surged to 8.38 per cent last month from 7.68 per cent in March and 1.96 per cent a year ago. Core inflation is also expected to remain high as manufacturers across sectors from automobiles to fast-moving consumer goods are likely to continue passing on high raw material costs on to retail prices.
Soumya Kanti Ghosh, group chief economic adviser at State Bank of India, sees a “sledgehammer approach” to curtail inflation with a 40 bps rate hike in June, followed by a 35 bps hike in August, apart from a 100 bps increase in CRR.
“The Russia-Ukraine conflict has significantly impacted the trajectory of inflation. The latest April inflation print shows wheat, protein items, milk, lemon, cooked meal, chillies, refined oil, potato, kerosene, firewood, gold and LPG are contributing to overall inflation in a substantive manner. We now expect RBI to raise rates both in June and August policy meetings by a cumulative 75 bps,” said Ghosh.
Rate hikes themselves won’t bring down food or fuel inflation, but can help check its generalisation by curbing the second-round effects, noted Dharmakirti Joshi, chief economist at CRISIL.
A sharp rise in inflation outlook, along with increasing pace of monetary policy tightening by major central banks, has completely eroded the already limited policy space available for RBI to support growth, he said.
“Although the RBI is shifting focus to inflation control, the 40 bps repo rate hike and 50 bps rise in CRR on May 4 were clear signals that rates will move only northwards in the foreseeable future. And, they will do so at a faster pace,” added Joshi, who expects the RBI to raise repo rates by another 75-100 bps in the remainder of the financial year ending March 2023.
That will mean cost of borrowing will go up across the board. Already, several banks and financial institutions have initiated a hike in their lending rates in the range of 25-40 bps. Deposit rates too have been raised.
Rajani Sinha, the chief economist at CARE Ratings, also expects overall repo rate to go up 75-100 bps in the current financial year, with a 25 bps hike in the June MPC meeting.
Upasna Bhardwaj, senior economist at Kotak Mahindra Bank, expects a sharper 35-40 bps hike in June. Overall, she expects policy rates to be raised by another 90-110 bps this year.
“While we expect April 2022 to have likely marked the peak for headline CPI inflation, the trajectory will witness a very slow descent, with all calendar year 2022 readings likely to remain above 6 per cent. This will intensify the pressure on the MPC to aggressively frontload policy rate hikes, especially with no near-term respite seen on the supply side and geopolitical tensions,” said Bhardwaj.
Due to the pandemic-era easy money policies, interest rates crashed to record lows. Home loans were being offered at interest rates as low as 6.5 per cent. But, with inflation playing spoilsport, the party may well and truly be over.
