RBI hikes repo rate by 40bps to 4.40%, CRR by 50bps, cites inflation worries

Reserve Bank of India (RBI) Governor Shaktikanta Das announced a 40-basis-point hike in the key lending rate and raised the cash reserve ratio (CRR) by 50 basis points in an unscheduled announcement on May 4. The move surprised markets pushing Benchmark Sensex down by 1474 points in the intra-day trade and pushing the yield on India's benchmark 10-year bond to 7.38 per cent.

One basis point is one hundredth of a percentage point. The revised repo rate now stands at 4.40 percent and the CRR at 4.5 percent.

Today’s decision should be seen as part of the central bank’s announcement last month of gradual withdrawal from easy money regime, Das said. “The decision today to raise repo rate may be seen as reversal of rate action of May 2020. In last month, we had set out a stance of withdrawal of accommodation. Today’s action need to be seen in line with that action.”

The surprise move  came ahead of an expected rate hike from the US Federal reserve and in the backdrop of retail inflation persistently staying above the central bank’s comfort zone.

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.

Repo is the rate at which the central bank lends short-term funds to banks. The RBI has cut the repo rate by 250 basis points since February 2019 to help revive the growth momentum. The Monetary Policy Committee has been on a prolonged accommodative stance to support growth.

In that sense, today’s announcement confirms the clear reversal of the rate cycle.

“I would like to emphasise that the monetary policy action is aimed at containing inflation spike and re-anchoring inflation expectation,” Das said. "High inflation is known as detrimental to growth."

The governor, however, added that monetary stance remains accommodative and actions will remain calibrated.

Rate cycle reverses 

Despite the continuation of accommodative stance, today's rate action confirms the reversal of the easy money regime the central bank had pursued during the start of the pandemic. In its response to the pandemic, monetary policy had shifted gears to an ultra-accommodative mode, with a large reduction of 75 basis points in the policy repo rate on March 27, 2020 followed by another reduction of 40 basis points on May 22, 2020.

However, in the April round of monetary policy, the  central bank had signaled exit from the easy money stance with several liquidity management measures in alignment with the shift in the monetary policy stance, including restoration of a symmetric LAF corridor around the policy repo rate and the introduction of the standing deposit facility (SDF).

"These measures operationalise the primacy accorded to maintaining price stability, while keeping in mind the objective of growth. Monetary policy has to engender an environment in which inflation persistence is broken and inflation expectations are re-anchored," Governor Das said in his statement.

Inflation worries return

The Governor stressed on the emerging risks of high inflation. Sustained high inflation inevitably hurts savings, investment, competitiveness and output growth, particularly that of poor segments, said Das.

"I would, therefore, like to emphasise that our monetary policy actions today – aimed at lowering inflation and anchoring inflation expectations – will strengthen and consolidate the medium-term growth prospects of the economy," Das said.