RBI hikes interest rate as expected, and keeps the door open for further hikes

Even as the Reserve Bank of India governor appeared on television screens on Wednesday morning, most people in the market were expecting an interest rate hike of 35 basis points (bps), i.e., 0.35 percent point. And this is just what happened. The interest rate increase we are talking about is on the repo rate, the rate at which the RBI lends funds to banks, if required, one day at a time. It went up from 5.9 per cent to 6.25 per cent. This rate is the pivot for interest rates in the entire economy. A hike in the repo rate today increases banks’ lending and deposit rates tomorrow. People’s antennae were up for a gauge on future rate hikes—whether there is any hint or softening of the stance—to gauge how the RBI would act at its next meeting on February 8, 2023. And the RBI kept its options open. If required, it will go in for another rate hike of, say, 25 bps.

Having said that, things can change over the next two months. There would be two more data points on inflation, that of November, to be declared in a few days from now and that of December, to be announced in January 2023. If inflation is on the higher side of expectations, that may be a case for another rate hike. There is a meeting of the Federal Reserve scheduled on December 14, where the US central bank is expected to hike the interest rate by 50 bps. This is known to markets and the RBI. What will be of relevance is the Fed’s outlook on future interest rate action. Global developments on geopolitical tensions, crude oil price (which has a big bearing on our inflation) and other prices would pan out over next two months. Moreover, the Union budget will be announced on February 1, 2023, i.e., just prior to the next RBI meeting on February 8. The extent of fiscal deficit announced in the budget and whether it is overall pro- or anti-inflationary would influence the RBI’s deliberations.

Other aspects of the review

In Wednesday’s policy review, the other variables that financial market participants would look at are inflation and GDP growth. The RBI’s projection on Consumer Price Index or CPI inflation remains similar to that of the previous policy review, which is 6.7 percent in 2022-23 and expected to ease to 5 percent in the first quarter of 2023-24. There is a minor upward tweak in inflation projections, in decimal points only. GDP growth projection for the current year, 2022-23, was revised downward from 7 percent earlier to 6.8 percent. A downward revision in growth projections implies the need for support from the RBI in terms of not-so-high interest rates. However, inflation is the bigger consideration for the central bank when it comes to interest rate decisions.