India’s rate-setting panel on Friday hiked the key lending rate, the repo rate, by 50 basis points (bps), taking the policy rate back to the late-2019 levels. One bps is one-hundredth of a percentage point.
"With inflation expected to remain above the upper threshold in Q2 and Q3, the MPC stressed that sustained high inflation could destabilise inflation expectations and harm growth in the medium term," said Reserve Bank of India (RBI) Governor Shaktikanta Das in his statement.
With the latest hike from the six-member Monetary Policy Committee (MPC), the repo rate now stands at 5.4 percent. Repo is the rate at which the central bank lends short-term funds to banks. Changes in this rate typically gets transmitted to the broader banking system. The MPC has cumulatively hiked repo rate by 140 bps in the current rate hike cycle.
The rate hike came on expected lines.
Most economists had predicted a 25-50 bps rate hike in the backdrop of a consistently high retail inflation that is hurting the common man. Already, the MPC had hiked the repo rate by 90 bps so far in this rate cycle.
The retail inflation has averaged above 6 percent for two consecutive quarters. If inflation stays above that level for three consecutive quarters, the MPC would have to explain the failure to the government. The RBI has now projected retail inflation at 6.7 per cent for FY 23 and real GDP growth at 7.2 per cent in FY 23.
"The inflation trajectory is now poised at a decisive point. While there are incipient signs of a confluence of factors that could lead to further softening of domestic inflationary pressures, there remain significant uncertainties," Das said.
The retail inflation remains too high. While inflation declined marginally in June to 7.01 percent from 7.04 percent in May, shop-end prices have now stayed above the medium-term target of 4 percent for 33 consecutive months and six straight months above the 6 percent upper bound of the RBI’s 2-6 percent tolerance range.
Growth is picking up pace, albeit slowly. The pandemic period had hurt all businesses and caused massive job losses. However, with lockdowns easing, economic activities have returned to near-normal levels as indicated by the improvement in collection rates of banks and two-wheeler sales.
The MPC’s rate hike is intended at curbing demand, and, thereby, controlling high inflation. However, much of the risks to inflation are emerging from external factors, including a huge upswing in global commodity prices and foreign fund outflows.
Foreign investors have pulled out $26.83 billion from Indian markets so far this year. The MPC is also under pressure because of a falling rupee, which has fallen close to 7 percent this year.
The latest round of rate hike is unlikely to prompt banks to pass on the impact in a big way, analysts say. That’s because banks have already hiked rates by a significant margin already this year. A further rate hike in loan rates could affect the nascent recovery seen in the economy in the post-pandemic period.
Announcing the decision, Das reiterated the central bank's commitment to maintain price and financial stability to place the economy on a sustainable path of growth.
"Our actions have helped the economy to tide over a series of shocks in the last two and half years. We are seized of our role at this critical juncture and will persevere in our efforts to ensure a safe and soft landing," Das added.
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