RBI Monetary Policy: Economists See Emergency Rate Lift-Off As Justified

India's Monetary Policy Committee caught financial markets off-guard, raising the benchmark repo rate by 40 basis points to 4.4% and the cash reserve ratio by 50 basis points to 4.5% amid rising inflation concerns.

Stock markets tumbled and bond yields spiked in response. Homebuyers, too, are expected to feel the pinch of higher interest rates as the rate cycle turns.

Economists, however, took comfort in the RBI's decision as a delay in rate hikes would have put the central bank further behind the curve. Inflation, at 7% in March, is already above the central bank's target and is likely to rise in April. The Monetary Policy Committee's move is expected to help anchor inflation expectations and prevent the second round effects of higher input costs.

In addition, with the U.S. Federal Reserve likely to step up the pace of rate hikes, India would have faced the collateral impact if rates in India were to be seen as falling behind its inflation targeting framework.

Rates Hikes: Onwards & Upwards

The large inter-meeting hike from the RBI indicates that tackling inflation risks is now front and center, Rahul Bajoria, chief economist at Barclays, said.

Given the hawkish rhetoric and high likelihood of an elevated inflation print for April, the RBI will be front-loading further hikes, he said.

The RBI would also look to reduce liquidity in a calibrated manner and may deliver another CRR hike of 50 basis points in the next MPC, applicable from a later date, Bajoria added.

Coming Soon: Neutral Real Interest Rates

The combination of 40 basis points hike in repo rate and 50 basis points hike in cash reserve ratio is an attempt by the RBI to preempt the rising inflationary pressures and be ahead of the curve, Suvodeep Rakshit, senior economist at Kotak Institutional Equities, said.

The bigger surprise was the CRR hike which indicates the RBI’s intent on withdrawing liquidity at a quicker pace.

While inflation is unlikely to decline in the near term, today’s move should help in pushing real rates towards neutral over the next few quarters. Rates across the curve will reprice factoring in a markedly more hawkish RBI. "We continue to expect cumulative 100-125 bps of repo rate hikes in FY23,” Rakshit said.

What's The Terminal Rate?

We continue to expect a 25 basis points repo rate hike in the upcoming June meeting, and the repo rate at 5.15% by end-2022, Pranjul Bhandari, chief economist at HSBC said.

A Boost For The Rupee

The persistence of high crude oil prices, and uncertainty over the length of the Russia-Ukraine war, have resulted in sustained inflationary pressure globally, Prasenjit Basu, chief economist at ICICI Securities, said. With the Chinese and Japanese currencies depreciating 4% and 6% respectively last month, emerging market currencies are under pressure.

Although the rupee has depreciated only 1.1% in the past month, any further downward pressure would have sparked worries about imported inflation. A timely rate hike was needed ahead of the inevitable U.S. rate hike expected this week, Basu said.

According to Basu, if the Russia-Ukraine war persists beyond May and June, more rate hikes will be needed.

Timing Of The Rate Hike

The crucial backing for the 40 basis points hike came from an understanding that inflation is here to stay, said Indranil Pan, chief economist at Yes bank.

The timing of the hike is important as it seems to just precede a likely 50-75 basis points increase in the policy rate by the U.S. Federal Reserve. This is possibly to ensure that the rupee is safe from any speculative attacks as forex reserves are down by around $30 billion from peak levels, he said.