Raises FY23 retail inflation projection to 6.7% from 5.7%; drops ‘accommodative’ in stance
The Monetary Policy Committee (MPC) today stepped up its inflation fight , with its members unanimously voting for an increase in the policy repo rate by 50 basis points.
The MPC move comes a little over a month after the six-member Committee unanimously voted for a 40 basis points hike in the repo rate in an offcycle meeting on May 4.
Following the latest hike, the repo rate is now 4.9 per cent up from 4.4 per cent. This will make bank loans (retail and MSME) linked to external benchmark rates such as the repo rate dearer.
The central bank revised its retail inflation projection for FY23 sharply upwards to 6.7 per cent (assuming a normal monsoon and average crude oil price — Indian basket — of $105 per barrel) from earlier projection of 5.7 per cent.
Inflation pain points
The Reserve Bank of India cited upside risks to inflation from high commodity, prices: high domestic poultry and animal feed costs; continuing trade and supply chain bottlenecks; the recent spike in tomato prices, and the elevated crude oil prices, among others.
RBI Governor Shaktikanta Das said that retail inflation has increased steeply, considerably beyond the upper tolerance level of 6 per cent, even as recovery has gained momentum despite the Covid pandemic and the Ukraine war. Das said around 75 per cent of the increase in inflation projections can be attributed to the food group.
The Governor said the MPC recognised that sustained high inflation could unhinge inflation expectations and trigger second round effects.
Hence, it judged that further monetary policy measures are necessary to anchor the inflation expectations. Accordingly, the MPC decided to raise the policy repo rate.
Along with the increase in the repo rate, the MPC also decided unanimously to remain focussed on withdrawal of accommodation to ensure that inflation remains within the target (of 4 per cent within a band of +/- 2 per cent) going forward, even while supporting growth.
While the phrase “remain accommodative” has been dropped from the MPC’s resolution, Das emphasised that the monetary policy stance is now focussed on calibrated withdrawal of the extraordinary accommodation extended during the pandemic.
“Our rate and other actions are calibrated to the evolving inflation growth dynamics. Inflation must come down, economic recovery also must continue. In terms of rates, we are still below the pre-pandemic level (of 5.15 per cent)… surplus liquidity is higher than the pre-pandemic level,” Das said, adding that the baseline inflation projection for FY23 does not take into account the impact of the monetary policy actions taken on Wednesday.
SDF, MSF rates up
Following the 50 basis points hike in repo rate, the standing deposit facility (SDF) rate has moved up to 4.65 per cent (4.15 per cent earlier); and the marginal standing facility (MSF) rate to 5.15 per cent (4.65 per cent).
Under SDF, banks can park surplus liquidity with the RBI, overnight or for longer tenors.
Under the MSF, banks can get funds from the RBI on overnight basis against their excess statutory liquidity ratio (government securities and state development loans) holdings.
Soumya Kanti Ghosh, Group Chief Economic Adviser, State Bank of India, said that with external benchmark lending rate linked loans gaining traction, the repo rate increase will curtail inflation through the credit channel as well. He assessed that every one basis point increase in the repo has a combined impact of around Rs. 305 crore on demand from retail and MSME consumers. So, with terminal repo rate at 5.75 per cent, there will be a reduction in demand from consumers to the tune of Rs. 45,000 crore.
To ease pressure on rupee
Dharmakirti Joshi, Chief Economist, Crisil, observed that a sharp rise in inflation outlook is forcing Mint Road’s hand, thereby speeding up the tightening. He said that the policy tightening is also warranted to reduce the pressure on the rupee from widening the Current Account Deficit (CAD) and stem foreign portfolio outflows.
“The RBI foresees inflation staying above 6 per cent in the first three quarters of this fiscal, amounting to four straight quarters of above-target reading. If the barometer stays above target for three consecutive quarters, the RBI is obliged to explain to the government,” he said.
Indranil Pan, Chief Economist, YES Bank, said the RBI has possibly built on the worst-case scenario on inflation expectations. “We still believe that the front loading strategy will continue and thus pencil in another 40-50 basis points increase in the repo rate in August. Thereafter the RBI may have to be more lenient in the extent of increases, keeping in line with its current inflation trajectory which also points to a sub-6 per cent number in the fourth quarter,” Pan said. By December, the RBI should raise the policy rate to 5.80-6 per cent and pause thereafter to assess the implications of the cumulative 180-200 basis points increase on both growth and inflation, he added.
Retains GDP growth
However, the central bank retained real GDP growth for 2022-23 at 7.2 per cent.