Just a year ago, as inflation was rearing its head, central banks still focused on aiding pandemic-ravaged economies, chose to look away terming the price increases as transitory. But, as it became clear that the inflation was here to stay for longer, central banks this year have had to quickly shift gears, rapidly mop up the excess liquidity in the system and raise record low-interest rates sharply.
The US Federal Reserve on Wednesday delivered another 75 basis points interest rate hike. The fourth consecutive 0.75 per cent hike, takes the benchmark Fed Funds rate to 3.75-4.0 per cent-- its highest level since 2008. This is the fastest pace of monetary policy tightening by the Fed in almost four decades.
The move is not surprising given that US inflation trending around 8 per cent is way more than the Fed’s 2 per cent target level. It is a similar situation in many other markets including the EU and UK. The Bank of England, for instance, has raised interest rates seven times since December and another rate hike is expected when it meets next on Friday.
The Fed itself is not done with its hikes yet and said post its latest meeting that in its battle to tame inflation, borrowing costs would have to rise further. However, it did signal that the inflection point may be near, suggesting that future rate hikes may not be as sharp.
The rate hikes in the developed world, especially by the Fed, have a big impact on emerging market economies, including India, which are also battling their problems, including inflation and uneven post-pandemic growth. Central banks, including the Reserve Bank of India, have had to factor in rising developed market interest rates in their own policy decisions too.
Already in 2022, foreign portfolio investors have pulled out more than Rs 1.64 lakh crore from India’s capital markets and the rupee has depreciated more than 7 per cent against the US dollar so far this financial year. As the dollar strengthens, investors typically will continue to head back to the safety of the greenback, as global geo-political and economic uncertainties continue. Continued dollar outflows, will further weigh on the rupee and hurt importers.
Incidentally, the RBI monetary policy committee had an unscheduled meeting today. On the schedule was drafting its response to the government on the issue of high inflation.
The consumer price index (CPI)-based inflation rose to a five-month high of 7.4 per cent in September. Under the law, RBI has to provide an explanation to the government on why it had failed to bring the inflation back within the 2 per cent to 6 per cent target band for three consecutive quarters in a row and what measures it was taking to address it.
The RBI began tightening interest rates only in May this year through an unscheduled meeting. Overall since it has hiked the benchmark repo rate (the rate at which it lends to banks) by 190 basis points. Still, inflation continues to trend above the Reserve Bank’s upper tolerance band.
Speaking at an event organised by industry body FICCI and the Indian Banks Association on Wednesday, RBI Governor Shaktikanta Das defended the way it had reacted, stating “it had prevented a complete downward turn of our economy.” Acting prematurely would have been “very costly” for the citizens of this country, he further said.
The central bank is unlikely to make its response to the government public right away, as it is a privileged communication between the two sides.
The RBI, in its response, could flag supply-side issues and the Russian invasion of Ukraine behind the high inflation. Das also said on Wednesday that its assessment in January-February this year had shown average inflation likely to trend around 5 per cent. But, the Russia-Ukraine war that began in February had changed the picture completely.
Another rate hike in the scheduled MPC meeting in December is widely expected.
Currently, the repo rate is at 5.90 per cent. Executives at HDFC Bank expect the RBI to raise the repo rate to at least 6.50 per cent or higher as “providing a currency defence becomes prominent on the RBI’s agenda.”
In its recent report, analysts at Goldman Sachs had forecast RBI could raise the repo rate by 35 bps in December and a further 50 bps later, which would take the benchmark rate to 6.75 per cent by April 2023.
