New Delhi: Reserve Bank’s surprise move to increase the benchmark interest rate, the repo rate at which banks borrow from the Central bank to meet their short term fund requirements, has surprised many as it was effected through an unscheduled monetary policy committee meeting. However, it was not completely unexpected as the retail inflation in March was above the RBI’s mandate of keeping it below six per cent which eventually forced the RBI’s hands to contain inflationary expectations.
Economists like Sunil Sinha, who is a macro-economist with India Ratings and Research and closely tracks government finances and Reserve Bank’s interest rate policies, had already predicted last month that despite the RBI’s decision to maintain the status quo in the first monetary policy of this fiscal, there was a strong case for raising the benchmark interest rate by 50 basis points (half a percent point) in June this year when the monetary policy committee was to meet for the second time.
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However, given the alarming rise in both the retail and wholesale inflation, the Reserve Bank took a U-turn on its policy stance and raised the repo rate by 40 basis points a month ahead of the schedule. As a result the repo rate under the liquidity adjustment facility now stands at 4.40%, and the standing deposit facility (SDF) rate is now 4.15% and the marginal standing facility (MSF) rate is now 4.65%. In addition to this, as a liquidity tightening measure, the Reserve Bank also increased the cash reserve ratio (CRR) 50 basis points (0.5%) to 4.5% of net demand and time liabilities. It will come into effect from May 21.
Sunil Sinha says now that RBI has raised the policy rate by 40 basis points (0.4%), the next question is when will be the next hike and how much. “Given that geopolitical situation and the global commodity prices are expected to remain in flux in the near term, more rate hikes in current financial year cannot be ruled out,” Sinha told ETV Bharat in a statement. He said that any future interest rate hikes will be data-dependent and may be in the range of 25-35 basis points.
Why RBI may hike rate again?
According to Sunil Sinha, even if the Russia-Ukraine conflict ends the global commodity prices are unlikely to revert to the pre-conflict level. Second, the supply-side disruptions would take time to ease. “All this means inflation would remain at elevated levels and there is a need to anchor the inflationary expectation before it gets entrenched into the system,” noted the economist.
In his speech today, the Reserve Bank Governor Shaktikanta Das mentioned the threat and said that there was a collateral risk that if inflation remains elevated at these levels for too long then it can de-anchor inflation expectations which, in turn, can become self-fulfilling and detrimental to growth and financial stability.
Adverse economic impact of Russia-Ukraine conflict
Sunil Sinha says that the RBI’s unscheduled action suggests the realization on the part of India’s central bank that the Russia-Ukraine conflict is unlikely to end any time soon and the evolving geopolitical situation is going to keep the domestic inflation higher than the tolerance band of the RBI. The argument to support growth is now somewhat less compelling as domestic economic activity is progressing broadly on the anticipated lines despite third Covid wave and even contact-intensive services sectors and investment activity are showing signs of gaining traction.
“Therefore, under the current growth inflation dynamics, the focus has to shift towards inflation lest it becomes detrimental to growth,” Sinha said while highlighting the rationale behind the rate hike decision.
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