RBI hikes rates by 50 bps, but OK with inflation target

5 Aug 2022 , 12:53 PM

The RBI governor concluded his statement with the famous quote from the Father of the Nation, “The road to salvation lies through incessant toil”. One thing the RBI governor has hinted is that the battle against inflation is going to long, hard and lonely for the Indian economy.

First, the background of the policy announcement. In its special monetary policy in May 2022, the RBI hiked the repo rates by 40 bps. The rates were again hiked by 50 bps in the regular June monetary policy. In its latest August monetary policy, the RBI has hiked rates by another 50 bps. That means a total rate hike of 140 basis points in the last 3 months, taking the repo rates 25 bps above the pre-COVID rate. But there is more to it.

With the repo rates at 5.40%, rates have climbed by 140 bps since May 2022. However, it must be remembered that the standing deposit facility (SDF) had already increased the LAF (liquidity adjustment facility) floor by 40 bps. Effectively, the RBI has already hiked rates by 180 bps since May. This was further amplified by a 50 bps CRR hike in May 2022. In short, there is a lot of underlying hawkishness in the RBI thinking.

RBI hikes repo rates by another 50 bps in August 2022

Ahead of the RBI policy of August 2022, the street was predicting rate hikes in the range of 25-35 bps. However, the RBI has chosen to err on the side of caution and hiked the rates by 50 bps to avoid any risk of monetary divergence with an incorrigibly hawkish US Fed. Here are the key takeaways from the RBI policy statement.

• The policy repo rate has been raised by 50 basis points from 4.90% to 5.40%, now a good 25 bps ahead of the pre-COVID repo rate levels of 5.15%.
• Consequently, the standing deposit facility (SDF), highlighted in the April policy, stands increased to 5.15%; 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 5.65% post the August 2022 repo rate hike.
• Like in the June policy, the RBI refrained from tinkering with the CRR rate in the light of the objections coming from the banks. The CRR stays at 4.5%.
• Inflation expectations for FY23 were kept static at 6.7%. The inflation expectation had already been hiked by 220 basis points since the first estimate for FY23.
• GDP forecast for FY23 has been maintained at 7.2%, and the latest IMF report projecting robust growth for India appears to have added to the RBI’s confidence.
• The MPC voted to remain focused on withdrawal of accommodation. Five members voted in favour while Jayanth Varma had objections to such a commitment.
• All the 6 members voted unanimously to hike the repo rates by 50 basis points to 5.40%. The hawkishness almost appears to be a consensus for the MPC members.

In terms of post policy market reaction, the markets have only consolidated on their strengths. There has been some pressure on auto stocks due to the higher cost of funds entailed in the repo rate hike. However, cement and infrastructure stocks look to be celebrating the robust growth projections.

MPC holds inflation projection at 6.7% for FY23

The MPC holding its inflation forecast for FY23 at 6.7% is hardly surprising with the CPI retail inflation coming down to 7%. Perhaps, once the CPI inflation comes close to 6% and WPI inflation trends below 15%, the MPC may consider lowering its inflation forecast for FY23. The RBI would be juggling two factors. On the one hand Brent Crude falling to $94/bbl is a major positive. However, a steeply higher current account deficit is weakening the rupee and that could result in a lot of imported inflation. So it will be a tightrope walk.

What is working for the RBI is that food, metal and oil inflation have tapered globally. There is also a concern over shortfall in paddy sowing, although overall Kharif output is expected to be better than normal this year. 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 6.4%, Q4FY23 at 5.8% and Q1FY24 at 5.0%.

Chart Source: RBI Policy Statement

One of the key targets for the RBI is to manage inflation expectations and in that it has been successful as inflation expectations have trended lower. That is likely to make the RBI’s hawkish policy stance more effective in terms of outcomes.

FY23 GDP growth held at a robust 7.2%

Despite the inflation tapering, the RBI has not made any upward revisions to its real GDP growth projections for FY23 at 7.2%. This is likely to happen, once the CPI inflation comes decisively below 6% and WPI also follows the trend. On the growth front, the RBI is betting heavily on brightening rural consumption on the back of strong agricultural growth. Most of the contact intensive sectors like trade, hotels and tourism, have shown a sharp turnaround, filling up the last available gap in the post-COVID recovery story.

However, the RBI has cautioned that there could be elevated risks to the GDP growth on account of rising geopolitical tensions. There is also the risk of global hawkishness reaching a crescendo as evident from recent actions of the US Fed, Bank of England and the ECB. The 7.2% GDP growth projection for FY23 has been broken up as under: Q1FY23 at 16.2%, Q2FY23 at 6.2%, Q3FY23 at 4.1% and Q4FY23 at 4.0%. Due to base effect, there is going to be a lot of front-loading of growth in the first two quarters.

Regulatory and development measures announced 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.

• RBI will introduce a code of conduct for outsourcing financial services. The draft guidelines for public comments is expected to be put out shortly.
• Credit Information Companies (CIC) like CIBIL will be brought under the RBI Ombudsman scheme. This will provide an alternate route for grievance redressal for customers of regulated entities, for complaints pertaining to CICs.
• Standalone Primary Dealers (SPDs) to be permitted to offer all forex related activities, just like Category-1 Authorised dealers, subject to prudential guidelines.
• RBI will set the tone to shift from the existing MIBOR to a more broad-based benchmark, as is the extant international practice.
• The NPCI’s Bharat Bill Payment System (BBPS) to be made available non-residents (NRIs) to efficiently meet their payment needs.

To sum it up, the RBI has retained its hawkish undertone. We should get greater clarity when the minutes are announced on 19th August. But, it will be global event flows that will determine the colour of the next monetary policy announcement on 30th September.