With the Reserve Bank of India’s Monetary Policy Committee (MPC) members voting to tame inflation expectations by tilting towards hawkish policy, experts are bracing for front-loaded interest rate hikes in the upcoming meetings, at least until the August meeting. RBI released the minutes of its off-cycle MPC meeting on Wednesday and cited ‘several storms’ hitting together as the reason for the monetary policy response. Experts see a 25-50 basis points rate hike in the upcoming June meeting of the Monetary Policy Committee.
“The (RBI MPC) minutes have reinforced the necessity to frontload withdrawal of policy accommodation amid increasing risk of inflation expectations getting unanchored,” Kotak Economic Research said in a note. Kotak expects 40 to 50 basis points (bps) rate hike in the upcoming June meeting, adding that it sees cumulative repo rate hikes of 110-135 bps by end of FY 2023. RBI’s MPC is scheduled to meet next between June 6 to June 8, 2022. Following this, the next meeting will be held after two months ie in August.
Two members of the central bank’s MPC, Jayant Varma and Aashima Goyal, said the high inflation in the country will require front-loading of interest rate increases, according to the minutes. Jayant Varma, an external member of the MPC, said, “It appears to me that more than 100 basis points of rate increases need to be carried out very soon.”
“The minutes confirm our view that policy is behind the curve and has to significantly catchup via front-loaded rate hikes,” Nomura economists Sonal Varma and Aurodeep Nandi wrote in a note Wednesday. “In view of the MPC’s focus on frontloaded hikes to get to 5.15% soon, we are tweaking our policy path slightly to a 50 bps hike in June (vs 35 bps earlier),” it added.
High inflation expectations may lead to repo rate hike to pre-pandemic level of 5.15% by August
The minutes stated that elevated inflation has been led by supply-side global macro conditions, though a monetary policy action was necessary to avoid second round effects on domestic inflation expectations. Consumer Price Index (CPI) inflation rose to a 8-year high of 7.79 per cent and crossed RBI’s upper tolerance limit of 6 per cent for the fourth straight month in May. Barclays recently said going ahead it sees inflation to remain above the RBI’s target band for three consecutive quarters (Q1-Q3 2022), marking the first official ‘failure’ of the monetary framework.
The RBI’s reaction function is now evolving with fluid macro realities and the central bank no longer thinks the output sacrifice required to tame supply-driven inflation can be so high on net, Madhavi Arora, Lead Economist, at Emkay said. Arora sees another 25 to 50 bps rate hike in June and a 100 to 125 bps hike in FY 2023.
Further monetary policy tightening after August to depend on growth
Emkay’s Arora, however, also said that the front-loaded rate-hiking cycle does not imply a lengthy tightening cycle. Once the RBI reaches the supposed neutral pre-covid monetary conditions, the bar for further tightening may incrementally be higher amid increasing growth-inflation trade-offs, she added. RBI’s repo rate stood at 5.15 per cent in February 2020, ie pre-pandemic.
Aditi Nayar Chief Economist at ICRA Limited said ICRA expects pre-pandemic level of the repo rate by August. “After that we expect a pause to see the impact of the rate hikes on economic growth. We foresee a terminal rate of 5.5% by mid 2023. Overtightening is not warranted in the current circumstances as inflation is being fuelled by global supply side factors, and may needlessly sacrifice domestic growth and sentiment,” Nayar added.
