RBI Hikes Repo Rate by 50 Bps
Unsurprisingly, the Reserve Bank of India (RBI) has withdrawn its accommodative stance by hiking Repo Rate by 50 bps to a two-year high of 4.90%, followed by 40-bps hike on May 4, in total 90bps has been done with a view to taming inflation are expected to lead to a further rise in interest rates in the banking system. New borrowers and existing floating rate borrowers will have to dole out higher EMIs for their loans.
The Monetary Policy Committee (MPC) of the RBI, in its bi-monthly policy review, has maintained its previous growth projection of 7.2% for 2022-23 despite “inflation concerns” and “negative spill-overs” from rising input costs, geopolitical tensions, and tightening of financial conditions. The World Bank had downgraded its growth forecast for India for the current financial year to 7.5%, a sharp 1.2 percentage points cut from its previous forecast of 8.7%. The RBI also projected inflation to rise to 7.5% for April-June this year and 6.7% for the full financial year, sharply up from the 5.7% it had projected in April for the full year and well above its 6% upper tolerance level.
In 2020, The RBI had to pump huge liquidity into the system to counter the impact of the Covid-19. While this, in turn, did support economic recovery, it turned out to be the main reason for the rise in inflation. In May, The RBI’s market operations led to a decline in liquidity. Still, overall system liquidity remains in large surplus, with the average daily absorption under the liquidity adjustment facility (LAF)moderating to Rs5.5 lakh crore during May 4-31, from Rs 7.4 lakh crore during April 8-May 3, in consonance with the gradual withdrawal of accommodation policy. Upward pressure on interest rates will also be put by the withdrawal.
The policy withdrawal and the rate hike are likely to impact consumption and demand in the economy. The impact might be more pronounced in non-discretionary spending by consumers. The forecast of a normal monsoon is expected to boost kharif sowing and agricultural output. This, in turn, will support rural consumption. There bound in contact-intensive services is likely to sustain urban consumption. RBI’s surveys suggest further improvement in consumer confidence and households’ optimism for the outlook a year ahead. The RBI’s optimism on growth is significant because the economy has performed in the first two months i.e. quite impressive. Interest rate hike ensures that growth is not affected as unchecked inflation can affect discretionary consumption, which in turn will affect growth.
These hikes in quick succession do not seem like the end of the rate hikes. Due to the current round of hikes, a wait and watch attitude can be adopted by apprehensive buyers. But on a positive note, the continued wage and job growth in varied sectors will provide a cushion in the short term for the purchasing decisions. Inflationary factors are yet to show any durable sign of subsiding. Till the time inflation comes down within the comfort zone of RBI, which 2-6%, it will be compelled to felicitate the interest rate hike option among other inflation control options. The government had to resort to the non-conventional way of curbing inflation which was by reducing the taxes on petroleum products. Also. Fuel and petroleum products can be placed under GST to give relief to people. However, there is only a marginal impact on growing inflation. Unless the global inflation comes down, the rate hike tool which the RBI will use to take out liquidity from the domestic financial system and contain inflation.