The move is expected to raise borrowing costs for corporates and individuals.
RBI’s monetary policy committee (MPC) held an off-cycle meeting on May 2-4, with all six members unanimously voting for a rate hike while maintaining the accommodative stance.
Central bank governor Shaktikanta Das said the decision of MPC reversed the May 2020 interest rate cut by an equal amount.
The markets faced heavy drubbing soon after the rate hike announcement. Sensex tumbled 1,306.96 points or 2.29 per cent to settle at 55,669.03. The move hit the investors hard as they became poorer by over Rs 6.27 lakh crore.
The RBI had last revised the policy rate on May 22, 2020, in an off-policy cycle to perk up demand by cutting interest rate to a historic low in wake of uncertainty surrounding the Covid-19 pandemic.
Today’s rate hike comes after 11 consecutive occasions when the RBI held policy interest rates at the same level.
In fact, this is the first-rate hike since August 2018 and the first instance of the MPC making an unscheduled increase in the repo rate (the rate at which banks borrow from the RBI).
The RBI has cut the repo rate by 250 basis points since February 2019 to help revive the growth momentum. The MPC has been on a prolonged accommodative stance to support growth.
Key policy rates
While repo rate or the rate at which RBI lends to commercial banks has been hiked by 40 bps, the governor did not mention anything about reverse repo rate. Hence, it remains same at 3.35 per cent.
The standing deposit facility rate is now at 4.15 per cent while the marginal standing facility rate and bank rate stand at 4.65 per cent.
The RBI also hiked the cash reserve ratio (CRR) by 50 bps to 4.5 per cent effective May 21.
This would drain Rs 87,000 crore of liquidity from the banking system, RBI governor said in a video address announcing the rate hike decision.
EMIs may rise
From October 1, 2019, all banks including SBI were mandated to lend only at an interest rate linked to an external benchmark, such as RBI’s repo rate or Treasury bills yield.
As a result, monetary policy transmission by banks has gained traction.
Banks obtain funds from RBI at this repo rate. When RBI hikes the policy rate, it becomes expensive for banks to acquire funds from the central bank. This, in turn, forces them to raise their lending rates as well.
Thus, a hike in repo rate by RBI often leads to a simultaneous hike in interest rates on loans given by banks.
Besides, the hike in CRR — which is the share of a bank’s total deposit that is mandated to be maintained by the RBI — is likely to put further pressure on interest rates.
Since banks will now need to park more money with the RBI, it will leave them with less funds to provide loans to consumers.
Therefore, people paying EMIs should be prepared for rise in monthly payments as banks may start raising interest rate on loans soon.
What propelled RBI to hike rates
While announcing the rare hike, RBI governor set out the rationale behind the MPC’s decision and stance. It is as follows:
* Globally, inflation is rising alarmingly and spreading fast. Geopolitical tensions are ratcheting up inflation to their highest levels in the last 3 to 4 decades in major economies, while moderating external demand.
* International crude oil prices continue to hover above $100 per barrel and this is prompting pass-through to domestic pump prices.
* The risks of unprecedented input cost pressures are translating into yet another round of price increases for processed food, non-food manufactured products and services are now more potent than before.
* Global food prices touched a new record in March and have firmed up even further since then. Inflation sensitive items relevant to India such as edible oils are facing shortages due to the conflict in Europe and export bans by key producers. The jump in fertiliser prices and other input costs has a direct impact on food prices in India.
* Further, the normalisation of monetary policy in major advanced economies is now expected to gain pace significantly – both in terms of rate increases and unwinding of quantitative easing as well as rollout of quantitative tightening. In fact, global growth projections have been revised downwards by up to 100 basis points for this calendar year. These dynamics pose upside risks to India’s inflation trajectory.
Persistent inflation pressure
The rate hike was announced with main objective of curtailing inflation that has remained stubbornly above the RBI’s upper tolerance limit of 6 per cent for the last 3 months.
Retail inflation based on consumer price index (CPI) jumped to a 17-month high of 6.9 per cent in March, while wholesale price inflation came in at 14.55 per cent.
RBI governor Shaktikanta Das said the inflation print in April is also likely to be high.
Soaring prices of food items amid hardening global commodity prices have put an added burden on household finances.
Das said MPC’s decision came amidst concerns over rising inflation, geo-political tensions, high crude oil prices and shortage of commodities globally. All this, he said, has impacted the Indian economy as well.
The RBI governor also noted that food inflation will continue to remain elevated as spillovers from global wheat shortages are impacting domestic prices, even though supplies remain comfortable.
Citing the reason of the ongoing war between Russia and Ukriane, Das said edible oil prices may firm up major producer countries have imposed export restrictions.
In its April MPC meet, RBI raised inflation forecast to 5.7 per cent for the current fiscal (2022-23), up from 4.5 per cent, and said it sees gross domestic product (GDP) growth during the year at 7.2 per cent compared to a previous expectation of 7.8 per cent.
Accommodative stance retained
Shaktikanta Das said that MPC will retain its accommodative monetary policy stance at a time when globally inflation is rising alarmingly even as investment activity is showing some traction in the country.
“The MPC judged that the inflation outlook warrants an appropriate and timely response through resolute and calibrated steps to ensure that second-round effects of supply-side shocks on the economy are contained and long-term inflation expectations are kept firmly anchored,” Das said.
“In the MPC’s view, monetary policy response at this juncture would help to preserve macro-financial stability amidst increasing volatility in financial markets,” he added.