What does the 35-bps increase in the key interest rate by the RBI mean?
Fighting inflation is still a top priority, and this fiscal year’s growth projection has been reduced to 6.8 percent from 7 percent.
The Monetary Policy Committee (MPC) of the current Reserve Bank of India raised the key policy rate, the repo rate, or also the rate at which the RBI lends funds to banks, by 35 basis points to 6.25 percent on Wednesday (December 7), signalling a further increase in lending and deposit rates. This move was made in an effort to control retail inflation.
In response to worries about the “bleak” global economic outlook, the MPC also reduced its growth forecast for the current fiscal year from 7% to 6.8% while holding the retail inflation forecast steady at 6.7%.
Was the decision to raise the RBI rate unanimous?
The six-member MPC, led by RBI Governor Shaktikanta Das, decided to raise the repo rate for the fifth time since May 2022 with the support of five members. The MPC also decided to keep concentrating on the withdrawal of accommodations by a vote of 4 out of 6 members.
What consequences will the RBI’s choice have?
Bank lending rates are anticipated to increase as the cost of funds is anticipated to continue rising. The EMIs for personal, home, and auto loans will also increase. Due to the fact that these loans are correlated to the repo rate, banks’ external benchmark linked lending rates (EBLR) will increase by 35 basis points (bps; one bps is equal to one hundredth of a percentage point). At this time, the Repo rate is a factor in up to 43.6% of all loans.
Banks’ loan portfolios’ margin-based lending rates (MCLR), which make up 49.2% of their total loans, are also anticipated to rise. The increase will aid in reducing national inflation.
In the near future, deposit rates are also anticipated to increase. The largest bank in India, SBI, now provides a 6.10 percent rate on one-year term deposits.
The Monetary Committee raised the rate for what reason?
To reduce inflation from its current rate, the RBI has raised the policy rate. Despite falling to 6.77 percent in October, a three-month low, inflation is still significantly higher than the Reserve Bank of India’s (4%) comfort level. The increase in core inflation, which is the portion of inflation that excludes food and energy, which edged up again after moderating over the summer, is what the central bank is most concerned about.
Additionally, households’ expectations for inflation are still high as long as food prices stay high. Given that imports make up a third of the CPI basket, RBI officials are becoming more concerned about inflation as a result of the rupee’s weakness against the US dollar.
In recent cycles, how has the interest rate changed?
Since the beginning of the tightening cycle in April 2022, the RBI has increased rates a total of 225 basis points (bps), trailing the US Federal Reserve’s 350 bps increases during the same time. Each of the last three increases in the repo rate was by 50 bps.
Further rate increases are likely to support the rupee and reduce underlying inflationary pressure. The RBI has already intervened to support the rupee. Analysts predict that the central bank will increase the interest rate to 6.50 percent by February 2023 and then maintain this level for the remainder of 2023. The RBI is likely to stop raising rates in 2023 if retail inflation slows down.
How has the transmission rate developed?
The weighted average lending rates (WALRs) on new and outstanding rupee loans have risen by 117 basis points and 63 basis points, respectively, from May to October 2022, according to the RBI. On the deposit side, during the same time period, the weighted average domestic term deposit rate on new and outstanding deposits rose by 150 basis points and 46 basis points, respectively. Das said, “We are closely monitoring this transmission process.
What are the growth and inflation projections from the RBI?
The flexible framework for inflation targeting calls for the RBI to mainly keep retail inflation at 4% (+/-2%). Real gross domestic product (GDP) for fiscal 2022–2023 was reduced by the rate setting panel from 7% in the previous projection made public during the September policy meeting to 6.8%. The MPC kept the inflation estimate for 2022–2023 at 6.7%.
The Reserve Bank of India’s Monetary Policy Committee (MPC) maintained its stance of “withdrawal of accommodation” and increased the benchmark rate by mere 35 basis points to 6.25 percent during its meeting in December. It maintained its current fiscal year inflation estimate of 6.7 percent while reducing its growth outlook from 7 percent to 6.8 percent (see table). Unusually, the World Bank raised its FY23 GDP forecast for India from 6.5 percent in October to 6.9 percent on Tuesday.
What are the messages conveyed by these growth and inflation scenarios? Although India’s GDP growth is still robust and inflation is predicted to be moderate, the fight against inflation is far from over. According to RBI governor Shaktikanta Das, pressure points from high and sticky core inflation as well as food inflation’s exposure to external factors and weather-related events still exist.
Das warned that significant shocks and previously unheard-of uncertainty continue to plague the world economy but reassured that India’s financial system is still strong and stable, calling it a main bright spot in an otherwise gloomy world. He added, “Banks and corporations are healthier now than they were before the crisis.
The central bank refused to provide any future guidance on rate hikes, saying that it would be flexible in its policy decisions, act in the best interests of the economy, and “obviously” take growth into account as it watched inflation dynamics. According to Das, “the direction of our future policy will duly take into account new data releases, the changing outlook of the economy, as well as the impact of our past actions.”
The majority of economists and analysts predict that the terminal repo rate will range between 6.25 and 6.5 percent. “While India’s growth continues to be more resilient, the governor made it clear that the current fight against inflation will continue. Therefore, it is evident that at least one more rate increase of 25 basis points will occur in CY23, according to Nikhil Gupta, chief economist at Motilal Oswal Financial Services.
As long as inflation is a concern, according to Lakshmi Iyer, CEO of Kotak Investment Advisors’ investment advisory division, the rate-hike cycle will continue. As concerns about global growth take precedence, she anticipates that the bond markets will give up some of their gains and trade in a range. She will also be keeping an eye out for US Federal Reserve policy cues.
The decision regarding the credit policy was not made unanimously, though. Five of the six members of the main rate-setting panel voted in favour of a rate increase of 35 basis points, while two MPC members abstained.
“The MPC remains divided, with two dissents opposing the current stance and one in favour of a pause, further indicating that the rate-hiking cycle is coming to an end. We anticipate a final, debatable hike of 25 basis points in February, followed by a hold. According to Aurodeep Nandi, vice president and India economist at Nomura, “we are currently pencilling in 75 basis points in recent cumulative cuts in H2 2023, taking repo rates back to currently 5.75 percent by end-2023.”
Das had stated a year prior that the RBI would take any necessary action to support a long-lasting recovery. At the final credit policy meeting of 2021, Das stated that broadening the growth impulses is the top priority at this point.
However, central banks around the world now have a bigger issue to solve after nearly two years of unprecedented liquidity and also low interest rates to combat a once-in-a-lifetime pandemic. On the one hand, after months of lockdowns and social restrictions related to COVID, nations must resurrect economic growth. Additionally, nations must control the inflationary crisis. One goal had to be sacrificed in order to achieve the other.
After months of a lacklustre policy response to the US Federal Reserve’s decision to raise benchmark rates to combat 40-year high inflation levels, Das, in an off-cycle emergency MPC meeting in May, finally cracked the whip on rising prices. Ironically, inflation was hovering around 7%, interest rates were at a historic low of 4%, and growth was stifled with scant signs of recovery.
Das had warned in May that there was a collateral risk if inflation remained high at these levels for too long because it might undermine inflation expectations, which could then become self-fulfilling and harmful to economic growth and financial stability.
In fact, inflation is likely to continue to rise above the MPC’s upper limit of 6%. (see table). Though it appears to be moving downward. Because of the uncertainty surrounding the outlook for food inflation, according to Tanvee Gupta Jain, economist at UBS India, “Inflation in India will also remain sticky and also stay above the RBI’s medium-term target of 4 percent in FY24.”
According to the RBI’s growth forecasts, India’s economy grew by 6.3 percent from July to September. According to NSO data, the domestic economy expanded by 13.5 percent in the previous quarter and 8.4 percent during the same period last year.
According to Nomura, the cycle of India’s growth rate has peaked and a general slowdown is under way. While lower inflation should support private consumption in the upcoming months, investment and exports will be hampered by the lingering effects of tighter financial conditions and weak global demand, while the post-pandemic catch-up in services is largely complete. According to its economists, GDP growth will slow from 6.8% year-over-year in 2022 to a below-consensus 4.7 percent in 2023.
Globally, demand is clearly slowing down, and central banks are aggressively raising interest rates. Despite having the fastest-growing major economy, some of India’s sectors that depend on exports may suffer. However, the domestic market is recovering. Whether the current pent-up demand will continue in the upcoming quarters and whether inflation will loosen its hold on the economy are still open questions.
edited and proofread by nikita sharma