MC Interview | Bank of Baroda's chief economist on why did RBI choose to hike rates off-policy

Reserve Bank of India (RBI) governor Shaktikanta Das announced a 40-basis-point (bp) hike in the key lending rate and raised the cash reserve ratio (CRR) by 50 bps in an unscheduled announcement on May 4.

This is the first such unscheduled statement from the RBI governor since the start of the pandemic in 2020. The announcement surprised the markets, pushing up bond yields and putting pressure on the equity indices.

In an interview with Moneycontrol, Madan Sabnavis, chief economist, Bank of Baroda, shares his views on the RBI rate hike. Edited excerpts:

Was the 40-bp rate hike a surprise?

Yes, it was a surprise for two reasons. There was no official data point which had come since the last policy except the CPI (Consumer Price Index) inflation number which anyway was expected to be close to 7 percent. Second, the quantum of 40 bps appeared to be high considering that the market was expecting 25 bps at a time.

Also Reads | Another 25 basis-point repo-rate hike likely in June: Experts

Why did RBI choose to hike rates off-policy?

Two reasons here. One is that the (Russia-Ukraine) war situation has gotten worse in terms of not seeming to end, which has caused inflation across all products. Second, there is an immediate need to steady balance of payments against the FPI (foreign portfolio investor) exit scenario being witnessed. With the Fed (US Federal Reserve) expected to raise rates, it became expedient to act fast.

Did the standing deposit facility or SDF rate at 3.75 percent compared to the reverse repo rate of 3.35 percent give an indication that a 40-bp rate hike was coming?

No. SDF will be the new non-collateral-based window to absorb excess liquidity and, hence, was fixed in the corridor of 25 bps. The reverse repo for all practical purposes is not relevant now.

Will today’s move by the RBI mean there will be a faster rate hike?

Yes. It will be data-driven and, hence, if inflation remains in the 7 percent region in April, which will be the next data point available before the next policy, we can see another 25 bps hike in June. On the whole we expect 50-75 bps more hikes this year, 50 bps for certain and another 25 bps if inflation is stubborn.

Why did the Sensex fall so sharply on Thursday, especially on the day of Life Insurance Corporation of India initial public offering opening?

The market never likes surprises and that is why it reacted the way it did. A sudden rate hike and CRR increase was not expected in the interim period. The same in June would not have mattered.

Will bond yields rise further from the 30-bp jump to 7.4 percent we saw on Thursday? What is your target?

Given the repo range of 4.90-5.15 percent, we are expecting the 10-year (bond) will go to the 7.5-7.75 percent range.

Why is the RBI hiking rates faster than expected?

Mainly to counter inflation, which is going out of control everywhere in the world.

Will lenders raise their lending rates?

Where rates are linked to repo it will go up. Further, as deposit costs go up, the MCLR (marginal cost of funds based lending rate) will also be raised by banks depending on their cost structure.

Will this rate hike weigh on corporate borrowing plans?

For companies doing well in terms of sales, it will not matter. However, those at the margins may defer investment when demand is weak. MSMEs (micro, small and medium enterprises) will be affected as their loans are linked to the benchmark repo.

Which part of the yield curve is attractive now?

For investors, a longer duration gives higher return.

The rate hike and market fall—will it affect the LIC IPO?

Not really, as those who invest in LIC do so for the value it brings. The RBI rate hike will not matter and the intrinsic strength of the company as perceived by the market will matter.