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Monetary policy: Will RBI follow other central banks? A case for 35-50 bps rate hike


RBI is not alone in the boat of rate hikes, major central banks are forced to increase key rates due to inflationary pressures which have rocked the economy in recent times. Recently, US Federal Reserve has made its third aggressive 75 basis points hike in the key rates, while European Central Bank raised the interest rates by a cumulative 125 basis points in the past two policies.

India’s central bank began its first hike for the current fiscal in a surprise move in May by 40 basis points. Later, in the June and August policy, RBI hiked the repo rate by 50 basis points each. Thereby, RBI has so far raised the policy repo rate by 140 basis points or 1.4%. At present, the repo rate stands at 5.4%.

The rate hike trend has pushed banks to increase their deposits and lending rates since May due to rising borrowing costs.

As of now, the country’s inflation stays above RBI’s upper tolerance limit for the eighth month in a row.

Due to the high inflation conundrum, the six-member MPC has also kept a focus on ‘the withdrawal of accommodation to ensure that inflation remains within the target going forward while supporting growth.

RBI targets to achieve CPI inflation of 4% with a minus or additional 2% band. In the August policy, RBI retained its projection for CPI inflation at 6.7% for fiscal FY23. It expects inflation to be at 7.1% in Q2, 6.4% in Q3, and 5.8% in Q4. For the first quarter of FY24, RBI predicts an inflation rate of 5%.

On the economic front, RBI retained its forecast of a GDP growth of 7.2% for FY23. The economy is seen to grow at 6.2% in Q2, 4.1% in Q3, and 4% in Q4 of the current financial year. However, RBI predicts real GDP growth of 6.7% in Q1 of FY24.

During the first quarter of FY23, India’s GDP missed market expectations and came in at 13.5%. RBI had predicted GDP at 16.2% in Q1FY23.

For the monetary policy that is set to be announced tomorrow, Ashish Chaturmohta, Director and Head, Advisory Research – JM Financial Services said, “Most street participants are pencilling yet another 35-50 bps rate hike by RBI in upcoming policy meeting. A combination of weaker Q2 GDP print, higher CPI (surprised on the upside in August at 7% YoY from 6.7%) & aggressive stance of FED to tame inflation is likely to force RBI to continue to front-load its policy actions. Even on the Currency Front USD/INR is testing life high levels of 81.66 as the USD continues to gain strength against most major currencies. RBI has already sold over $ 90 billion of FX reserves over the last one year to about $ 545.6 billion its lowest level since past 2 years. On the brighter side though even though Q2 GDP growth came in below expectations, consumption and investments remains strong, high-frequency activity data also points towards strong consumption near festive season. We believe that the softening commodity (-9%) and crude prices (-6%) would reflect in RBIs policy decision during their Sep’22 meet. Given considerable uncertainty, we expect the MPC to remain ambiguous and data dependent.”

How much rate hike to expect from RBI in September 2022 policy?

According to Sriram Iyer, Senior Research Analyst at Reliance Securities, RBI could hike rates by 50 bps when they meet this week to cool stubbornly high inflation and prevent the currency from weakening further. The Federal Reserve in their September meeting delivered a 75bps hike while signalling larger increases in the next few months. The Fed’s new projections showed policy rate rising to 4.4% by the end of this year, and to 4.6% in 2023 and a rate cuts are not foreseen until 2024. The Dollar surged higher as the market quickly realized that the rate hikes and more importantly, the expected path of rate hikes was not factored into market prices.

Iyer pointed out that till date in 2022 the RBI has hiked rates by a total of 140 basis points while the Fed has hiked rates by 300 basis points. So, a larger hike would also confirm RBI does not remain behind the Fed’s pace after the recent 75 basis points by the Fed has reduced the gap with Indian policy rates to just 225 bps as against the traditional gap of 300 basis points.

Jyoti Prakash Gadia, Managing Director, Resurgent India also expects a 50 basis points rate hike from RBI in Sept policy. Gadia said, “The sticky inflation, consistently above the benchmark rate in the last three months ,alongwith non-abating food price rise will force RBI to have a hawkish view and a 50 basis point rise in repo rate is expected in the next policy review by RBI.”

On macroeconomic indicators, Gadia said, “the inflationary trends are expected to continue and we have the supply side constraints too, in addition to the rising prices and interest rates across the globe. The world economy is heading towards recession, which will adversely impact the growth prospects of India also and this may lead to a review of the growth projections by RBI too.”

Additionally, Resurgent India’s MD said, “With the RBI hands being virtually tied in the current interest rising regime, no surprises are expected from RBI at this stage and it shall work towards taming inflation. The onus shall lie on the Government to continue its efforts to boost investment with suitable fiscal measures and reforms, for ensuring a firm revival and growth trajectory. On the liquidity front, RBI may work towards Stop taking further steps of absorption of liquidity, given the current upsurge in short term rates.”

However, Rohin Agarwal, Vice President at Avener Capital expects over 35 basis points hike. Agarwal said, “With Fed leading the pack in hiking rates and other central following suit this month, the stage seems set for RBI to hike rates in upcoming MPC by 35+ bps to protect the rupee as well as contain inflation. While the rate hikes have been aimed at demand side, inflation is now threatening to regain it’s upward trajectory due to supply side constraints. RBI will have to evaluate the impact of rate hikes going forward and play a balancing act”.

Notably, Yes Bank’s Ecologue report highlighted that the rate hike cycle may be longer and deeper. Economists here stated that India’s macro-economic landscape is looking vulnerable now and India is once again starting at a twin-deficit problem. RBI’s Foreign Currency Assets (FCA) are now at around $485 billion and the RBI has already expended close to $56 billion to contain the depreciation of the currency. There have been some discussions in the market if the RBI can once again raise dollar resources via some bond instruments. We think that it could be challenging to do so immediately as the interest differential have dipped to unattractive levels. We need to remind ourselves that the success of the FCNR (B) deposits in 2013 was on the back of an interest rate differential of close to 600 bps, led by the RBI’s sledge-hammer action of increasing the market operative rate by 300 bps. This was further sweetened for the banks with the RBI allowing banks to swap the receipts under the FCNR (B) deposit scheme at a fixed rate (that was lower than the market rate at that time),” Yes Bank’s note added.

Yes Bank’s note mentioned that “the point being made is that we do not see any significant scope for India to go down the route of issuing bonds externally to raise resources and contain the depreciation of INR. Thus, the RBI would remain open to using the interest rate as a tool to correct for the interest differential and hence contain the pressures for INR depreciation. Even as we have consistently pointed that the RBI’s monetary reaction function is based more on domestic dynamics than blindly following the Fed, this time around, there could be a closer momentum of repo rate increases by the RBI to the global monetary policy cycle.”

“Central banks across the world, led by US Fed upped their hawkish tone and are now ready for a larger growth sacrifice in their efforts at containing inflation. Subsequently, INR depreciated sharply and with the interest rate differential between India and the US falling to a 12 year low of ~340bps, capital flows are unlikely to be supportive. Inflation pressures for India could sustain with INR depreciation and also due to a relatively weak Kharif season. We now expect the RBI to hike the repo rate by 50bps on 30th September and continue raising for the next two policies for a terminal rate of 6.50% by end-March 2023,” Yes Bank’s note further said.

Apart from the repo rate, RBI kept the standing deposit facility (SDF) rate adjusted at 5.15%, while the marginal standing facility (MSF) rate and the Bank Rate at 5.65%.

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