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RBI raises repo rate by 50 bps to above pre-pandemic level as inflation worry continues

Petrochemical industry | 05 Aug 2022 12:55 IST | Polymerupdate.com

The Reserve Bank of India (RBI) raised its key repo rate (an interest rate at which the central bank lends money to commercial banks) by 50 basis points (bps) to 5.4 percent on Friday, the third increase in a row, to tame inflation which remained above the central bank’s tolerance limit of 6 percent for a sustained period. With this increase, the key policy rate crossed the pre-pandemic level of 5.15 percent.

Announcing the interest rate after the three-day Monetary Policy Committee (MPC) meeting held between August 3 and 5, RBI governor Shaktikanta Das, said, “Since the MPC meeting in June 2022, the global economic and financial environment has deteriorated with the combined impact of monetary policy tightening across the world and the persisting war in Europe heightening risks of a recession. Although the CPI inflation eased to 7 percent (year on year or y-oy-) during May-June 2022 from 7.8 percent in April, it continues to persist above the upper tolerance band. Looking at all these macroeconomic factors, the MPC members unanimously voted to raise the interest rate by 50 bps with immediate effect.”

Consequently, the standing deposit facility (SDF) rate stands adjusted to 5.15 percent, and the marginal standing facility (MSF) rate and the Bank Rate to 5.65 percent. The MPC also decided to remain focused on the withdrawal of accommodation to ensure that inflation remains within the target going forward while supporting growth.

“These decisions are in consonance with the objective of achieving the medium-term target for consumer price index (CPI) inflation of 4 percent within a band of +/-2 percent either side while supporting growth,” said the governor.

Gripped by risk aversion, global financial markets, have experienced surges of volatility and large sell-offs. The United States dollar index soared to a two-decade high in July. Both advanced economies (AEs) and emerging market economies (EMEs) witnessed the weakening of their currencies against the US dollar. EMEs are experiencing capital outflows and reserve losses which are exacerbating risks to their growth and financial stability.

“RBI raised the interest rate for the third consecutive month since May’22 by cumulatively 140 bps in its effort to contain inflation. Despite this sharp hike, RBI expects inflation to remain above its comfort zone and has retained its CPI inflation forecast at 6.7 percent for FY’23. RBI expects India’s GDP growth to remain strong at 7.2 percent in FY’23. We believe, the commodity prices have cooled off including crude oil, and the inflation may be peaking out. We expect RBI may not be very aggressive in its subsequent policy meets and being more data-driven based on inflation numbers,” said Motilal Oswal, Managing Director and Chief Executive Officer, Motilal Oswal Financial Services Ltd.

Meanwhile, spillovers from geopolitical shocks are imparting considerable uncertainty to the inflation trajectory. More recently, food and metal prices have come off their peaks. International crude oil prices have eased in recent weeks but remain elevated and volatile on supply concerns even as the global demand outlook is weakening.

The appreciation of the US dollar can feed into imported inflation pressures. Rising Kharif sowing amid a normal monsoon forecast augurs well for the domestic food price outlook. Experts forecast input cost pressures to soften across sectors in the second half of the current financial year. However, cost pressures are expected to get increasingly transmitted to output prices across the manufacturing and services sectors. Taking into account these factors with the crude oil price of the Indian basket of US$ 105 a barrel, RBI retained inflation at 6.7 percent for the financial year 2022-23 with 7.1 percent in the second and 6.4 percent in the third quarter. CPI projection for the financial year 2023-24 is forecast at 5 percent.

“RBI has been compelled to take steps to control India’s consumer inflation which has remained above the tolerance level of 6 percent. So far the commercial banks have transmitted the policy rate hike to borrowers, resulting in an increase in lending rates across all sectors including real estate. Today’s rate hike will further harden the rates. In terms of liquidity, the measures have cut the extent of the liquidity window. However, adequate liquidity is managed, and improved manufacturing capacity utilization will be supportive of credit growth going forward,” said Shishir Baijal, Chairman and Managing Director, Knight Frank India.

While interacting with the media, RBI governor Shaktikanta Das said, “Indian economy remained on the island of growth and macroeconomic stability. There are signs CPI has peaked but remained at an uncomfortably high level. It’s expected to moderate in the fourth quarter. Hence, RBI has taken a calibrated and calculated view on repo rate with 50 bps hike has become new normal globally.”

Meanwhile, RBI hinted that rural consumption is expected to benefit from the brightening agricultural prospects. The demand for contact-intensive services and the improvement in business and consumer sentiment should bolster discretionary spending and urban consumption. Investment activity is expected to get support from the government’s capex push, improving bank credit and rising capacity utilization.

On the other hand, elevated risks emanating from protracted geopolitical tensions, the upsurge in global financial market volatility, and tightening global financial conditions continue to weigh heavily on the outlook. With all these factors in place, the RBI retained GDP forecast at 7.2 percent for FY 2022-23 with 16.2 percent, 6,2 percent, 4.1 percent, and 4 percent for the first, second, third, and fourth quarters of FY 2022-23 respectively.

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