RBI hikes 35 bps to 6.25%, says farewell to hawkishness

7 Dec 2022 , 11:33 AM

With repo rates already at 5.90%, the RBI was under pressure to ensure that growth did not falter due to too much hawkishness. However, with inflation still in the range of 6% to 7%, the RBI rightly decided to find a compromise. The 35 bps rate hike gives out the right signal that the RBI is still serious about fighting inflation. At the same time, it also emits the first signal that its choice would now shift to nurturing GDP growth. In a way, that was a good choice with the Fed likely to announce its last policy for the Calendar Year 2022 on 14^th December.

For the RBI, as Governor Das has consistently underlined, the policy choices represent the horns of a dilemma. It cannot afford to let its policy slip on inflation control since it has larger implications for demand, consumption and expectations. At the same time, the RBI cannot be seen to be diverging too much from the Fed in terms of monetary stance, as it could impact the colour of flows into India. Above all, the RBI also has the current account deficit and the rupee to worry about; and both have been very vulnerable in last one year.

RBI hikes repo rates by another 35 bps to 6.25%

This time around there was no element of surprise in the policy statement and the outcome was exactly what the markets had already anticipated. The markets had factored in 35 bps rate hike after indications from the Fed that the central bank of the world’s largest economy could go slow on rate hikes. Here are important points from the RBI policy statement.

• The policy repo rate has been increased by 35 basis points from 5.90% to 6.25%. Repo rates are now a full 110 bps above the pre-COVID repo rate levels of 5.15% and inching towards the likely terminal rate range of 6.50% to 7.00%.
• Consequently, the standing deposit facility (SDF), automatically stands increased to 6.00%; pegged 25 basis points below the repo rate. In April 2022, the SDF had replaced the erstwhile reverse repo rate mechanism.
• The bank rate and the marginal standing facility (MSF) rate, pegged 25 bps above the repo rates, go up to 6.50%. With rapid transmission already evident in India, this hints at a further spike in borrowing costs; something evidenced in Q2FY23 results.
• Inflation expectations for FY23 were retained at 6.7% but the GDP growth expectations have been further lowered by 20 bps to 6.80%. In the 30th September policy, the RBI had lowered the growth estimate from 7.20% to 7.00%; so it is 40 bps in two policies.
• A total of 5 out of 6 members voted to hike repo rates by 35 basis points to 6.25%, with Dr. Jayant Varma the sole dissenting voice. Withdrawal of accommodation found 4 out of 6 votes in favour with Jayant Varma and Ashima Goyal opposing the resolution.

This looks a lot more like a market friendly monetary policy with a focus on what the markets want rather than purely from a regulatory perspective. Whether this sets the tone for the future, would also depend on the Fed policy announcement on 14^th December.

Inflation retained at 6.7% for FY23, GDP growth lowered 20 bps

In nutshell, the expected inflation for FY23 has been retained at 6.7%, the GDP growth estimate for FY23 has been lowered by 20 bps to 6.80%. That makes it a 40 bps growth downgrade by the RBI in the last 2 policies. Here is what the RBI governor said about growth and inflation in his speech.

• Why did the RBI not lower inflation estimates for FY23, despite sharply lower oil prices? According to the RBI governor, there are positives in the form of weak crude and sharply higher sowing acreage for the Rabi season. However, with a large trade deficit, imported inflation could offset most of the advantages.
• The tone of the RBI governor in his speech was that the inflation problem was far from over. According to Das, most of the supply chain constraints still remain and the sticky nature of core inflation indicates that inflation could rear its head once again. That is something India must be prepared for.
• Lastly, the RBI has underlined that despite cutting growth forecast for FY23 by 20 bps from 7% to 6.8%, one cannot miss out the resilience story in India. For instance, the Q2FY23 GDP growth at 6.3% was much higher than the most optimistic estimates on the street. While India may not have decoupled from global markets, its huge domestic market size makes it less vulnerable. Das underlined that even at 6.8% estimated GDP growth for FY23, India would outpace China by 300-400 bps and remain the fastest growing large economy in the world.

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 4 key announcements made as an addendum to the policy.

• For SLR holdings, banks can hold 23% of NDTL in the HTM (held to maturity category) up to March 2023. This limit used to be 19.5% before. Now, the RBI has extended this limit to March 2024 to allow banks to better manage their investment portfolios.
• UPI now dominates the volumes in terms of digital payments, even as NEFT continues to dominate the value sweepstakes. RBI will now introduce single-block and multiple-block debit functionality in UPI transactions for which NPCI will issue detailed instructions.
• The Bharat Bill Payments System (BBPS) will be expanded to encompass all payments and collections under its ambit. However, BBPS cannot handle recurring transactions, so it is difficult for regular mandates. Now, BBPS will support recurring transactions too.
• A new mechanism to allow resident Indians to hedge their gold risk in the global markets is being conceived. They can hedge this risk through stock exchanges located at the International Financial Services Centre (IFSC) to manage gold price risk more efficiently.

RBI has given a toppish message on rates indicating that the RBI may be approaching the terminal repo rate soon. We have to await the minutes on 21st December for greater clarity. The Fed policy on 14^th December and the inflation number should set the tone for the next RBI policy scheduled between February 06^th and February 08^th 2023.