RBI hikes rates by 50 bps to 5.90% as inflation pinches

30 Sept 2022 , 01:07 PM

RBI first hiked rates by 40 bps in the special monetary policy in May 2022. Since then, the June policy, August policy and the latest September policy have seen 50 bps rate hike each. In 4 months between May 2022 and September 2022, the RBI has effectively hiked repo rates by 190 basis points from 4.00% to 5.90%. It may not be as steep as the US Fed (3 hikes of 75 bps each), but then the negative real rate in India was also never that bad.

However, the 190 bps rate hike is not the full picture. In addition, the RBI had already hiked the LAF (liquidity adjustment facility) floor for standing deposit facility (SDF) by 40 bps. The RBI had also hiked the CRR by 50 basis points in May. To that extent, the RBI has also been extremely hawkish, although its language has never been as brutally hawkish as the US Federal Reserve.

While we get down to the nuances of the policy announcement, the gist of the policy statement is quite clear. Notwithstanding its sober language, the RBI would leave no stone unturned in bringing down inflation. It would also not expose the Indian markets to the risk of monetary divergence; and the concomitant volatility that it brings along. Monetary policy in India would be work-in-progress and that was best summed up in the Mahatma’s words by the RBI governor, “We are ever wakeful, ever vigilant and ever striving”.

RBI hikes repo rates by another 50 bps to 5.90%

This time around there was no element of surprise in the policy statement. The markets had already factored in 50 bps rate hike after August CPI inflation had risen to 7%. Here are the key takeaways from the RBI policy statement.

• The policy repo rate has been increased by 50 basis points from 5.40% to 5.90%. Repo rates are now a full 75 bps above the pre-COVID repo rate levels of 5.15%.
• Consequently, the standing deposit facility (SDF), highlighted in the April policy, stands increased to 5.65%; pegged 25 basis points below the repo rate.
• The bank rate and the marginal standing facility (MSF) rate, pegged 25 bps above the repo rates, go up to 6.15%, hinting at more expensive borrowings.
• The CRR stays at 4.5%. In fact, after the 50 bps hike in May 2022, the RBI has refrained from tinkering with the CRR, following objections from the banks.
• Inflation expectations for FY23 were retained at 6.7%. RBI expects the impact of sobering commodity prices to gradually factor into inflation with a lag.
• GDP forecast for FY23 has been lowered by 20 bps from 7.2% to 7.0%, mainly due to the lower Q1 GDP at 13.5% and headwinds on the global demand front.
• All the 6 members voted unanimously to hike repo rates by 50 basis points to 5.90%. Only 5 out of 6 MPC members voted to remain focused on withdrawal of accommodation without impacting growth. Jayanth Varma was against a commitment.
• An important issue that arises is the terminal repo rate. It was supposed to be 6%, but now RBI indications are that 6.5% could be a more likely terminal repo rate.

The stock market reaction post the policy underlined that there were really no negative surprises in the policy. That is good enough to excite the stock markets in these troubled times, when headwinds are just too many.

MPC retains inflation projection at 6.7% for FY23

Despite the consumer inflation rising in August, the MPC opted to retain its inflation forecast for FY23 at 6.7%. with the WPI inflation tapering sharply, the RBI is confident of waiting for the lag effect of the commodity price fall to rub off. However, the inflation is expected to remain above the upper tolerance limit of 6% for the rest of FY23. Apart from softening global commodity prices, the RBI is also betting on the late recovery in Kharif output and strong prospects for Rabi output to soften food prices.

However, despite these positive signals, the RBI has underlined that a lot of inflation could be the outcome of geopolitical risk and global risk factors, over which there is little policy control. RBI feels that the pass through of lower input costs was not happening quickly enough and that could lead to inflation falling with a lag. Consequently, the RBI has held full year FY23 inflation at 6.7%. This has been broken up as under: Q2FY23 at 7.1%, Q3FY23 at 6.5%, Q4FY23 at 5.8% and Q1FY24 at 5.0%. Expectations are relatively stable.

Chart Source: RBI Policy Statement

However, one point to note is that the RBI has underlined it would keep hiking rates till inflation expectations came down. That indirectly raises the terminal repo rate target to 6.5% or even higher, depending on how the situation pans out.

FY23 GDP growth cut by 20 bps to 7.0%

There are some reasons to be positive on the growth front. The 20 bps cut in full year GDP growth is not much considering that risk of global recession is still quite high. Also, global headwinds like the Ukraine war and the political turmoil in Russia (and also in China) suggests that the recession possibility could be sharper. That is also evident from the US real GDP contracting for the second quarter in succession. However, there are some green shoots in India to be optimistic about.

The RBI is of the view that, despite global headwinds, the government thrust on capex, the revival in rural demand and the sharp growth in services sector should offset the global risks. Also, urban demand typically strengthens in the festive season in the second half of the year. The 7.0% GDP growth projection for FY23 has been broken up as under: Q2FY23 at 6.3%, Q3FY23 at 4.6%, Q4FY23 at 4.6% and Q1FY24 at 7.2%. RBI sees very minor impact on India’s real GDP growth despite global headwinds.

Key policy measures appended by the RBI

In last few years, RBI has used the policy statement to provide additional signals on the regulatory front. Here are some key announcements.

·         Loan loss provisioning by banks will move from an incurred loss approach to an expected loss approach. This is the global standard and a discussion paper is expected shortly.

·         RBI will also issue a discussion paper on securitization of stressed assets as against the current available mechanism for securitization of standard assets.

·         Current regulations applicable to online payment aggregators may be applied and extended to offline payment aggregators too.

RBI has retained its hawkish undertone till inflation expectations are under control. We are looking at a higher terminal repo rate of 6.5% or higher We should get greater clarity when the minutes are announced on 14th October. The next meet from December 05-07 could be a lot more critical in terms of long term trajectory.