Cautious RBI raises policy rate by 50bps

The increase, which takes the policy rate to 5.4%, a level last seen in August 2019, will increase borrowing costs for companies, make home loans expensive, and possibly crimp demand.

The Reserve Bank of India’s Monetary Policy Committee (MPC) on Friday increased its policy rate by 50 basis points (0.5 percentage points), the third consecutive hike since May, when the committee sat for an unscheduled meeting.

Cautious RBI raises policy rate by 50bps. (AFP)

The increase, which takes the policy rate to 5.4%, a level last seen in August 2019, will increase borrowing costs for companies, make home loans expensive, and possibly crimp demand.

RBI also left its growth and inflation projections for 2022-23 unchanged after its August meeting that ended Friday; at 7.2% and 6.7% respectively, these indicate that the central bank believes inflation remains the larger concern — and that its policy action will not materially affect growth.

Although the latest data seems to suggest that inflation may have peaked, RBI may be worried about possible volatility in energy prices, analysts said. RBI has increased the policy rate sharply, from 4% in April to 5.4% at the end of Friday’s action.

MPC’s latest decision to hike policy rates by 50 basis points – one basis point is one hundredth of a percentage point – is in keeping with the forecast by a Bloomberg poll of economists. RBI raised the policy rate by 40 and 50 basis points in its (unscheduled) May and June meetings as well. Experts believe that the central bank will hike rates further in this calendar year, although a large quantum might have already been front loaded.

“RBI unveiled its April-June 2023 inflation forecast at 5%. Earlier it has spoken about real neutral rates at 1%. Combining the two, we think the repo rate can be raised to 6%. We expect rate hikes in the two remaining meetings of the year, taking the repo rate to 6% in December this year,” Pranjul Bhjandari, chief India economist at HSBC said in a research note. Repo rate, or the policy rate, is the one at which RBI lends to banks.

“Domestic economic activity remains resilient”, the MPC resolution said, even as it expressed concern over the fact that “since the MPC’s meeting in June 2022, the global economic and financial environment has deteriorated with the combined impact of monetary policy tightening across the world and the persisting war in Europe heightening risks of recession”. However, the resolution did note green-shoots in the economy. “The demand for contact-intensive services and the improvement in business and consumer sentiment should bolster discretionary spending and urban consumption. Investment activity is expected to get support from the government’s capex push, improving bank credit and rising capacity utilisation”.

On the issue of inflation, while the MPC noted that some international prices, including that of crude oil, have come down from their peak levels, spillovers from geopolitical shocks continued to impart “considerable uncertainty to the inflation trajectory”. The resolution also noted that the shortfall in paddy sowing needs to be watched carefully even though it underlined the adequacy of India’s food reserves.

The latest MPC resolution also suggests that the meeting deliberated on the growing challenges on the external front including the deprecation of the rupee. The rupee dollar exchange rate which was 77.72 against a dollar on June 8, when the last MPC meeting concluded, stood at 79.12 on August 5. It had fallen to an all-time low of 79.98 per dollar July 21, as per data on RBI’s reference rate from the Centre for Monitoring Indian Economy.

“EMEs (emerging market economies) are experiencing capital outflows and reserve losses which are exacerbating risks to their growth and financial stability,” the resolution noted. To be sure, the Governor underlined that there was no imminent crisis as far as India’s balance of payment situation was concerned. “Export of goods and services together with remittances are expected to keep the current account deficit within sustainable limits,” Das said in his statement.

“This is the third consecutive rate hike in the last two months and finally marks the end of the all-time best low-interest rates regime -- one of the major factors that drove housing sales across the country since the pandemic. This whammy comes along with the inflationary trends of primary raw materials, including cement, steel, labour, etc., that have recently led to a rise in property prices. Together, these factors – rising home loan rates and construction costs – will impact residential sales that did reasonably well in the first half of 2022,” Anuj Puri, Chairman Anarock Group, a real estate services company said in a statement.

The NSE Nifty 50 ended 0.1% higher at 17,397.5, a change of 15 points from Thursday’s close. The S&P BSE Sensex ended 89 points higher, at 58,387.9.