RBI may increase rates by 35 to 50 basis points

by Shanti Ekambaram

In an off-cycle policy review, the Reserve Bank of India (reserve Bank of India) announced an increase of 40 basis points (bps) in the repo rate to 4.40% on May 4, 2022, in response to the sharp and sustained increase in the inflation print. The central bank had also changed its narrative to control inflation and normalize liquidity to pre-Covid levels. As the Monetary Policy Committee (MPC) prepares for a three-day hiatus from June 6-8, 2022, rising inflation and price stability will remain two key factors in deciding the rate trajectory.

global inflationary pressures

Geopolitical tensions, rising commodity prices and local and global inflationary pressures will be the top concerns of the MPC. Consumer inflation hit an almost eight-year high of 7.79% in April, staying above the RBI target for the fourth consecutive month. In tandem, wholesale inflation continued in double digits and reached a record high of 15.1% in April 2022. Shortage of supply chain, rising input costs and fuel prices further increased the level of inflation.

Government steps in to announce reduction in fuel prices, hike in export duty on select steel productsand deduction of customs duty for many items like coking coal, naphtha, ferro-nickel etc. In addition, the government approved an additional expenditure of Rs 1.1 trillion for fertilizers and a LPG subsidy 200 per cylinder. This is to reduce inflationary pressure. Thus, monetary and fiscal policies have moved together and need to be continued.

A slightly positive result emerged in terms of GDP growth for FY22, which is projected to grow at 8.7%. Q4FY2021-22 GDP recorded at 4.1%, which is lower than 5.4% measured in Q3FY2021-22.

Fiscal and monetary policies must go together

In the previous policy, the MPC decided to remain accommodative, focusing on the gradual return of housing to support growth.

The stance will likely be “neutral”, while the RBI remains committed to bringing inflation closer to the target levels through all possible means. The terminal repo rate is likely to settle anywhere between 5.50% and 6%.

Against this background, I expect the RBI to increase rates by between 35 and 50 basis points. Depending on external factors including inflation data and oil and commodity prices, the latter could rise by 25 basis points.

Inflation and rate hikes can affect economic growth, especially discretionary spending. India has been a predominantly consumption-driven economy, which is critical to supporting growth over the long term. I believe that monetary policy alone is not sufficient to control inflation because it is not “demand-based”, but rather supply constraints – and “cost pushes” – lead to inflation. Fiscal and monetary policies must move together to bring inflation within target levels and support economic growth. Thus, targeted government measures are needed to control inflationary pressures and balance the growth-inflation trade-off.

(The writer is Group President – Consumer Banking, Kotak Mahindra Bank, Views expressed are the author’s own)