The Reserve Bank of India’s (RBI) monetary policy committee on Friday expectedly voted to raise the repo rate by 50 basis points (0.5 per cent). This is the fourth consecutive repo rate hike, which lifts the benchmark rate at which it lends to commercial banks to 5.90 per cent now from the 4 per cent at the beginning of May.
The hike was warranted by the sharp interest rate hikes by global central banks, which RBI Governor Shaktikanta Das said was a third major shock after the COVID-19 pandemic and the conflict in Ukraine, which already had a profound impact on the global economy.
“We are in the midst of a third major shock – a storm – arising from aggressive monetary policy actions and even more aggressive communication from advanced economy central banks. The necessity of such actions is driven by their domestic considerations, but in a highly integrated global financial system, they inevitably cause negative externalities through global spillovers," noted Das.
Earlier this month, the US Federal Reserve raised its benchmark Fed Funds Rate by 75 basis points for a third consecutive time. The Fed has raised interest rates by 300 bps between March and September this year, taking the policy rate to 3.0-3.25 per cent, as it battles inflation running at a four-decade high.
The rising US interest rates have strengthened the dollar and hit other currencies, particularly emerging market (EM) currencies, hard. In the current financial year, the rupee has depreciated 7.4 per cent to the dollar, although it has fared better compared with a few other reserve and EM currencies. Overall, the dollar has appreciated 14.5 per cent against a basket of major currencies, pointed Das.
He said that the RBI does not have any fixed exchange rate in mind and it intervenes in the market to curb excessive volatility and anchor expectations.
“The overarching focus is on maintaining macroeconomic stability and market confidence.”
As of September 23, RBI’s foreign exchange reserves stood at $537.5 billion. Das said that about 67 per cent of the decline in reserves in the current financial year was due to valuation changes arising from an appreciating dollar.
Inflation remains a concern for the Reserve Bank too. Although the problem may not be as severe as in the US or Europe, retail inflation in India has remained above the 6 per cent upper tolerance level of the RBI for eight months now. Bringing prices under control also warranted tighter monetary conditions.
"Acute imported inflation pressures felt at the beginning of the financial year have eased but remain elevated across food and energy items," noted Das.
As supply conditions ease and crude oil and metal prices soften, there could be some tapering of selling price increases going forward, felt Das. However, with services activity showing a strong rebound and some improvement in pricing power, risks of higher pass-through of input costs do remain, he said.
There are also upside risks to food prices.
"Cereal price pressure is spreading from wheat to rice due to the likely lower kharif paddy production. The lower sowing for kharif pulses could also cause some pressure. The delayed withdrawal of monsoons and intense rain spells in various regions have already started to impact vegetable prices, especially tomatoes. These risks to food inflation could have an adverse impact on inflation expectations," said Das.
For now, the central bank has retained the average retail inflation projection for the 2022-23 financial year at 6.7 per cent. It sees inflation at 7.1 per cent in the September quarter, 6.5 per cent in the December quarter and 5.8 per cent in Jan-March. CPI (consumer price index) inflation is further expected to moderate to 5 per cent in the April-June quarter of the next financial year.
“If high inflation is allowed to linger, it invariably triggers second-order effects and unsettles expectations. Therefore, monetary policy has to carry forward its calibrated action on policy rates and liquidity conditions consistent with the evolving inflation growth dynamics. It must remain alert and nimble,” stressed Das.
Taking into account the various headwinds, the RBI has slightly lowered its GDP growth projections for the current financial year to 7 per cent from the 7.2 per cent it had expected earlier.
India’s manufacturing purchasing managers index (PMI), indicates sustained expansion at 56.2 in August. Business sentiment, as reflected in the manufacturing PMI, strengthened with the degree of optimism at its highest in six years, pointed Das. Services PMI also rebounded to 57.2 in August from 55.5 in July.
While these factors should support aggregate demand and activity, the “headwinds from extended geopolitical tensions, tightening global financial conditions and a possible decline in the external component of aggregate demand can pose downside risks to growth,” opined Das.
In recent weeks, the aggressive monetary policies of central banks in developed economies have roiled capital markets. India’s benchmark stock indices, after suffering losses for seven straight sessions, regained on Friday intra-day with the RBI monetary policy on expected lines. The rupee also gained in intra-day trading and bond yields rose.