The Reserve Bank of India (RBI) raised the repo rate by 40 basis points to 4.40% with immediate effect in an unexpected announcement ahead of the US Federal Reserve’s decision on interest rate revision amid high inflation woes.
An increase in repo rate, which is the rate at which the central bank lends to commercial banks, means interest rates on loans are likely to increase leading to an uptick in monthly installment payments and the overall household budgets for Indians.
The RBI also increased the cash reserve ratio (CRR), the minimum reserve or percentage of cash commercial banks have to maintain with the central bank, by 50 basis points to 4.50%. RBI Governor Shaktikanta Das said the Bank will continue to remain accommodative till inflation remains within the target going forward, while supporting growth.
The RBI’s medium-term target for consumer price index (CPI) inflation stands at 4% within a band of +/- 2%, while supporting growth. In March 2022, headline CPI inflation emerged to 7.0% from 6.1% in February, largely reflecting the impact of geopolitical spillovers.
The standing deposit facility (SDF) rate stood adjusted to 4.15% and the marginal standing facility (MSF) rate and the bank rate to 4.65%.
Geopolitical Tensions Main Concern
The Russia-Ukraine conflict, which began in March 2022, has had a stifling inflationary impact worldwide as global commodity prices have risen since and international crude prices have remained high and volatile including prices of inflation sensitive items that are impacted by global shortages due to output losses and export restrictions by key producing countries thereby increasing the cost of everyday consumption items.
With the European crisis, the central bank notes downside risks to have increased due to disruptions, shortages and escalating prices.
Another area of concern is the resurgence of Covid-19 led to renewed lockdowns and supply chain disruptions in major economies could sustain higher logistics costs for longer. Amid the Covid-19 pandemic, the RBI had cut interest rates to a record low of 4% in May 2020, which was aimed at easing liquidity and had significantly reduced the cost of financing.
The RBI expects domestic economic activity to pick up at the back of forecast of a normal southwest monsoon, recovery in contact-intensive services to be sustained with growing vaccination coverage and investment activity to be uplifted aided by robust government capex and stronger corporate balance sheets.
The central bank sees the Indian economy capable of weathering the deterioration in geopolitical conditions but it is prudent to continuously monitor the balance of risks.
Das reiterated that the RBI will ensure adequate liquidity in the system to meet the productive requirements of the economy in support of credit offtake and growth.
Indian indices, both NIFTY 50 and BSE S&P Sensex, fell sharply on the RBI’s off-cycle rate hike. Nifty closed down 2.29% to 16,677 and Sensex fell over 1300 points. Majority of stocks ended in red as the market awaits the US Fed’s imminent hike in interest rates.
Sorbh Gupta, equity fund manager at Quantum AMC, thinks RBI’s surprise move will not have an immediate bearing on growth in inflation but it is an indication of things to come.
“These types of events will come and go multiple times in an investor’s journey to achieving financial goals and one should not be swayed too much…Investors should stick to their asset allocation plans and use a staggered approach to increase allocation to equities,” Gupta said .
The impact of inflation is being felt worldwide. The Bank of England recently raised UK interest rates to 0.25% following inflation data that showed the UK’s cost of living grew by 5.1% in the 12 months to November this year, its highest level in more than 10 years.
In the US, some observers believe that the FOMC could raise the federal funds rate by 50 basis points in its upcoming meeting, double the March increase, as it attempts to stamp out the highest rates of US inflation in more than 40 years.