RBI surprises market with hawkish tone

In the Merriam Webster dictionary, “stealing the thunder” refers to pre-empting someone else from taking the initiative and the praise. What the RBI did on 04th May 2022 was nothing short of stealing the thunder. Even as the markets were discussing how much the Fed would raise rates on 04th May, the RBI virtually stole the monetary thunder by hiking repo rates by 40 bps. Remember, the normal course for a rate hike has always been 25 bps. By hiking the repo rates by 40 bps, the RBI has sent out a clear signal that it would not flinch when it comes to price stability.

Not just the size, but also the timing

The market was taken by surprise, not just by the size of the 40 bps rate hike, but also the timing. It has been announced just a few hours ahead of the Fed meet, virtually hinting that monetary policy in India would just chart its own trajectory. Here are the highlights of the announcements made in the Special Meeting of the MPC convened on 04th May.

• The policy repo rate has been raised by 40 basis points from 4.00% to 4.40% and this hike would be effective with immediate effect.
• As a result the standing deposit facility (SDF) highlighted in the April policy stands increased to 4.15% at 25 basis points spread below the repo rate.
• The bank rate and the marginal standing facility (MSF) rate remain pegged 25 bps above the repo rate at 4.65%, moving up correspondingly with the repo rates.
• The reverse repo rate stays at 3.35%, but with the introduction of the SDF, the role of the reverse repo rate had become largely redundant.
• To amplify the impact of the rate hike, the RBI has also tightened liquidity by hiking the cash reserve ratio (CRR) by 50 basis points from 4.0% to 4.5%.
• The MPC voted to remain accommodative but also committed to ensure that inflation stayed within the stipulated limits.
• All the 6 members voted unanimously to hike the repo rates by 40 basis points. Since the last MPC meet, Dr. Rajiv Ranjan has come into the MPC in place of Dr. Mridul Saggar.
• The MPC also voted to remain accommodative while focusing on gradual withdrawal of accommodation to rein in inflation in the stipulated range.

What triggered the decision for an unscheduled repo rate hike?

In the April monetary policy, RBI governor Shaktikanta Das, had indicated that there were tectonic shifts happening. Perhaps, the rate hike could have come in April, but they wanted more confirmation that growth was getting back on track. With the latest high frequency confirmation coming from the GST collections at Rs1.68 trillion, the signals on the growth front are quite unambiguous. That gives enough scope for RBI to target inflation.

There were several reasons for the RBI to be positive on growth. With the Omicron wave waning, private consumption was regaining traction and contact-intensive services were recuperating amidst rising discretionary spending. The latest forecast of a normal southwest monsoon in 2022 (fourth year in succession) also underscores the growth potential for the agricultural and concomitant sectors. Even as margins have been under pressure, the top line has been helped by stable demand, better capacity utilization, lower debt and a massive surge in exports. This is despite the global headwinds from oil, Ukraine and China.

If growth was encouraging, inflation was not. The worrying factor was the Mar-22 inflation at 6.95%, propelled by food prices. The oil and commodity story is already well-known and needs no reiteration. RBI was also sceptical that the hike in pump prices would seep through to all products and services. RBI expects food inflation to get more intense due to factors like global wheat shortage, disruption in supply chains, rise in edible oils due to the Indonesian export ban and a spike in feed prices.

It is in the above light that the MPC deemed it fit to implement an unscheduled repo rate hike in May. The June MPC will be conducted as scheduled.

Why did the RBI also hike the CRR by 50 basis points

The cash reserve ratio (CRR) refers to highly liquid assets that banks maintain with the RBI as a percentage of its total payables. The rate of CRR has been hiked by 50 basis points from 4.0% to 4.5% of Net demand and time liabilities (NDTL). An increase in CRR has 3 possible implications. Firstly, CRR is a safety measure to ensure solvency in the banking system, so solvency improves. Secondly, the hike in CRR limits the ability of banks to create credit, since credit has a multiplier effect. Lastly, it reduces consumer lending and thus cuts the liquidity overhang in the system.

In a way, the repo rate hike is the primary strategy to control inflation and the CRR hike is the amplifying strategy. If inflation has to be controlled, it is not just enough to tighten rates but liquidity has to also be moderated. In April alone, the total absorption through SDF and VRRR auctions amounted to Rs750,000cr. In addition, the withdrawal of liquidity through this 50 bps increase in CRR would be to the tune of Rs87,000cr. The RBI is confident that the repo rate, hike amplified by the CRR hike, would help rein in inflation in the range of up to 200 bps around the targeted 4% mark.

External resilience has been the saving grace

The RBI governor rightly point out that India’s external resilience amidst the supply chain constraints had been the saving grace. What India may have lost out due to supply chain bottlenecks have been compensated by a number of factors. For example, the spike in prices of agricultural and industrial commodities have helped boost India’s exports to new markets. Secondly, the situation in Russia and China have created opportunities for India to tap newer markets. One direct outcome was exports touching $420 billion in FY22 and staying elevated at above $38 billion in Apr-22.

A lot will still predicate on what the Fed does and how the global prices of oil shape up. But at a policy level, the RBI has definitely stolen the thunder. In the process, the RBI governor has also ended up surprising the Indian equity and bond markets!