As inflation pressure builds, RBI raises key rate by 50 bps, signals more hikes

The Reserve Bank of India (RBI) on Wednesday raised its main policy rate, the Repo rate — the rate at which it lends money to commercial banks — for the second time in over a month by an expected 50 basis points in its bid to tame runaway inflation. It has projected inflation to remain above its upper tolerance band of 6 per cent through the first three quarters of FY23 (April-December 2022).

The central bank has now raised the Repo rate by 90 basis points to 4.90 per cent in a matter of five weeks, with the hikes set to raise the lending rates in the banking system and impact the demand in the economy. The rate hike will force banks and non-banking finance companies to increase lending rates and result in higher equated monthly installs (EMIs) of existing borrowers.

Moreover, new home, vehicle and personal loans will also become costlier. However, analysts say that consumption and demand can be impacted by the Repo rate hike

The Monetary Policy Committee of the RBI, in its bi-monthly policy review, has maintained its previous growth projection of 7.2 per cent for 2022-23 even as it admitted to “inflation concerns” and “negative spillovers” from geopolitical tensions, rising input costs and tightening of financial conditions. The World Bank Tuesday had slashed its growth forecast for India for the current financial year to 7.5 per cent, a sharp 1.2 percentage points cut from its previous forecast of 8.7 percent.

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The RBI also projected inflation to rise to 7.5 per cent for April-June this year and 6.7 per cent for the full financial year, sharply up from the 5.7 per cent it had projected in April for the full year and well above its 6 per cent upper tolerance level.

Explained

Tightrope walk for the RBI

To cause minimum disruption to growth while quelling inflation pressures, the RBI’s 50 basis point rate hike shows a calibrated withdrawal of accommodative stance. By not hiking the CRR, the central bank has ensured that banks are not constrained to lend.

Maintaining that the economy remains resilient to global challenges and that it is witnessing recovery, RBI Governor Shaktikanta Das pointed towards rising rail, port and air traffic, GST collections, improving capacity utilisations, rise in bank credit disbursals and signs of improvement in rural and urban demand. The RBI’s policy panel, chaired by the Governor, also unanimously voted to remain focused on “withdrawal of accommodation” to ensure that inflation remains within the target going forward. Marking an end to the low interest rate regime, the RBI had on May 4 raised Repo rate by 40 basis points and cash reserve ratio (CRR) by 50 basis points, which led to a hike in lending and deposit rates by banks.

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“Our effort will be to move closer to the target of 4 per cent (plus or minus 2 per cent). We believe that our actions will have their impact in bringing down inflation and inflation expectations and we are committed to bringing it down,” Das said. He further said that the central bank is now focused on withdrawal of the accommodative stance as the surplus remains higher than pre-pandemic levels whereas the rates are still below the pre-pandemic levels.

When asked if the RBI will be aggressive in its approach to tackle inflation, he said that RBI’s future course of action will depend on how inflation evolves and said the situation is very uncertain. “These are extremely uncertain conditions, and it is not possible to provide an outlook on guidance… we will deal as the situation arises,” Das said. Addressing the media later, he said that RBI does not want to take any “abrupt rushed action that may be detrimental to the system and the markets.”

Despite the challenges of inflation, the Governor indicated continuing support to the economy. He said the liquidity withdrawal will be “calibrated and measured” and will see that it meets the credit requirements of the ongoing economic recovery. Stating that the capacity utilisation improved to 74.5 per cent in the quarter ended March 2022 from 72.4 per cent in the previous quarter, Das said capacity utilisations are likely to increase further in 2022-23.

“Going ahead, while normalizing the pandemic related extraordinary liquidity accommodation over a multi-year time frame, the Reserve bank will ensure availability of adequate liquidity to meet the productive requirements of the economy. The Reserve Bank will also remain focused on orderly completion of the government’s borrowing programme,” the Governor said in his statement.

Stressing on the resilience of the economy, the governor said that he does not see any crisis-like situation. While he expects the current account deficit to remain at sustainable levels, “we have built strong buffers and reserves that will help us in any situation”, Das said. While projecting the inflation of 6.7 per cent for the current financial year, he said that 75 per cent of the increase in inflation projection can be attributed to food inflation, which in turn is linked to the war in Ukraine.

In its bi-monthly statement, the MPC said the headline inflation increased by about 170 basis points between February and April and “with no resolution of the war in sight and the upside risks to inflation, prudent monetary policy measures would ensure that the second- round effects of supply side shocks on the economy are contained, and long-term inflation expectations remain firmly anchored and inflation gradually aligns close to the target.” The monetary policy actions including withdrawal of accommodation will be calibrated keeping in mind the requirements of the ongoing economic recovery, it said.

Prior to the May 4, 2022, hike, the RBI last hiked the Repo rate by 25 bps to 6.50 per cent in August 2018. From the 8 per cent level in January 2014, the Repo rate was reduced to 4 per cent by May 2020 After the RBI slashed the rates over the years to boost growth – the last cut was by 40 basis points in May 2020 to tackle the negative impact of the pandemic.

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