Monetary policy: RBI shifts gaze to inflation from growth after 2 years | Business Standard News

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Sets stage for rate hikes after June policy amid high oil prices, yields

shakikanta das

RBI Governor Shaktikanta Das. Illustration: Ajay Mohanty

The increase in pump prices of petrol and diesel by a steep Rs 10 in the fortnight following surging crude oil prices over $100 a barrel has been the factor in the Reserve Bank of India (RBI) turning its attention to inflation over growth, which was its focus since the pandemic came in March 2020.

The central bank on Friday indicated it was preparing to withdraw the accommodative stance, sending bond yields to a three-year high. The six-member Monetary Policy Committee (MPC) unanimously voted to keep the policy rate, or the repo rate, unchanged at 4 per cent. The accommodative stance too was unchanged, but with a caveat. The central bank said it would focus on withdrawing from it.

“The MPC decided unanimously to remain accommodative while focusing on withdrawal of accommodation to ensure that inflation remains within the target going forward, while supporting growth,” RBI Governor Shaktikanta Das said in a departure from his earlier comments over two years that the accommodative stance would be maintained “as long as necessary to revive and sustain growth on a durable basis and continue to mitigate the impact of Covid-19 on the economy”.

This change in language probably ensured all the members voted in favour of this resolution. One of the external members, Jayanth Varma, had voted against the stance in the last four policies.

“In the sequence of priorities, we have now put inflation before growth. For the last three years, starting February 2019, we had put growth ahead of inflation in the sequence. This time we have revised that because we thought the time is appropriate,” Das said during the post-policy interaction with the media, which was in physical mode, again a first since the pandemic broke out two years ago.

The central bank changed its growth projection downward and raised its inflation projection — mainly due to the impact that the economy is facing after Russia attacked Ukraine. The GDP growth forecast was revised to 7.2 per cent for FY23 from 7.8 per cent projected during the February meeting.


The inflation projection has been revised sharply from 4.5 per cent to 5.7 per cent for FY23. Both the projections were made after assuming crude oil prices at $100 a barrel.

“The inflation projections, which would attract a lot of attention, have been revised upwards due to war-induced factors … The stance continues to be accommodative while focusing on withdrawal of accommodation,” Das said.

The central bank decided to return to its original mandate after inflation stayed above its upper tolerance limit in January and February, and is expected to be more than 6 per cent in March, and also in the first quarter of current financial year, according to the central bank’s projection, which is 6.3 per cent. For the June-September period, the CPI inflation rate is projected at 5.8 per cent.

“… while the RBI is still maintaining its accommodative stance, it is interesting that within the last couple of months, the RBI has gone from being ultra-accommodative to talking about withdrawal of accommodation,” said Aurodeep Nandi, India Economist at Nomura.

The RBI is answerable to the policymakers if it misses its target of achieving the 4 per cent CPI inflation rate, give or take 2 percentage points, for three consecutive quarters.

Though the key policy rates were not touched, the central bank was mindful that the time had come for short-term rates to inch up. As a result, the RBI deployed a tool that was not so far used — the standing deposit facility (SDF), which will act as the lower end of the policy corridor, offering 3.75 per cent to banks.

The corridor is the difference between the rate at which banks park their excess liquidity with the RBI and the rate at which they borrow from the RBI. The upper end of the corridor will now be the marginal standing facility. The RBI will now absorb liquidity under the SDF instead of the reverse repo rate, which pushes up the short-term rates by 40 bps at one go. The RBI has also clarified that deposits under the SDF will be an eligible asset for maintaining the statutory liquidity ratio (SLR).

“The RBI changed its stance away from accommodative without actually calling it so, and made an effective rate hike of 40 bps without actually hiking any rates, and has introduced a tool (SDF) to sterilise unlimited surplus liquidity but choosing it to do over a multi-year horizon,” said Pankaj Pathak, fund manager (fixed income), Quantum AMC.

The yield on the 10-year bond jumped 21 bps to 7.12 per cent in response to the withdrawal of the accommodation focus. The five-year overnight indexed swap (OIS) jumped over 30 bps to its highest since May 2019, signalling a sharp recalibration of interest rate hike expectations.

“Based on Friday’s moves, we believe that if growth risks do not rise and the inflation outlook does not improve, the RBI will change its policy stance to neutral in the June MPC meeting, setting the stage for a short rate hiking cycle in H2 2022,” said Rahul Bajoria, managing director and chief India economist, Barclays.

While the money market rates will tighten, lending rates of banks are unlikely to change in the near term.

“Since the repo rate is unchanged, bank loans linked to the repo rate will not be affected, and the governor has assured of sufficient liquidity,” said A K Goel, managing director and chief executive officer, Punjab National Bank, who is also chairman of the Indian Banks’ Association.

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