*Policy normalisation is back with RBI making surprise rate hike | Business Standard News

Clipped from: https://www.business-standard.com/article/economy-policy/policy-normalisation-is-back-with-rbi-making-surprise-rate-hike-122050400699_1.html

The rate hike was expected in June, but clearly the central bank sees inflation path as being quite ominous to trigger such an action.

Madan Sabnavis, chief economist, CARE Ratings (Photo: PHOTO CREDIT: Kamlesh Pednekar)

Madan Sabnavis, is the chief economist at Bank of Baroda. (Photo: PHOTO CREDIT: Kamlesh Pednekar)

The Reserve Bank of India (RBI) has surprised the market with a repo rate hike of 40 basis points (bps), which is between 25-50 bps, and hence an odd number given that multiples of 25 have been the rule till the pandemic. It is a surprise because between the last policy and today there has been only one data point of high CPI inflation in March that is available. The Ukraine war, however, continues impacting prices of several commodities due to supply disruptions.

It does look like that finally the monetary policy committee (MPC) has turned its attention to inflation, which is expected to be high in April too, and probably the rest of the quarter. It has also been mentioned that the committee is more sanguine on growth as India has done better than its peers. The rate hike was expected in June, but clearly the MPC sees inflation path as being quite ominous to trigger such an action.

The language, however, is different as it has been stated that the move to increase the repo rate is more of a reversal of the accommodation provided during the Covid times of 2020 and a part of the strategy of withdrawal of accommodation stated in the April policy.

Inflation, as can be seen, has been primarily on the supply side with crude oil prices or edible oil prices being triggered by global factors. The same holds for metal prices where India is a price taker. Therefore, there is reason to believe that these factors will prevail as long as the war and supply-side disruptions last. By hiking the rate it does signal that the excess demand forces will be curbed.

The second prong used is to raise the cash reserve ratio (CRR) by 50 bps, which is a direct absorption of liquidity from the system. This is probably a bigger surprise as the quantum of surplus liquidity is very high. A 50 bps rise in CRR would only partly affect this amount, but sends a strong message that the overall policy is no longer accommodative.

What will be the impact?

An increase in repo and CRR has had the immediate desired impact. The market has already reacted with the 10 year bond moving towards 7.5 per cent. It will probably revert to the 7.220-7.25 per cent region, but given that the present repo rate hike is to be seen as the beginning of the rate spiral, the bond yields will tighten further and move towards 7.50-7.75 assuming another 50-75 bps hike in repo rate during the year.

Growth will remain volatile in terms of prospects, as the present high inflation would come in the way of consumption that in turn can push back investment. Rising interest rates will also work on investment decisions as companies will expand capital plans only where there is demand. Therefore, both the consumption and investment cycles can get affected.

One thing for sure is that the days of easy money are over and while one cannot be certain if excess liquidity and low rates helped to bring about incremental growth, industry will face a challenge for sure this time as rates keep increasing. The normalization has finally started.

(Madan Sabnavis, is the chief economist at Bank of Baroda and author of: Lockdown or Economic Destruction. Views expressed in this article are personal.)

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