Citing elevated levels of inflation, which remains above RBI’s upper target band of 6 per cent, the Monetary Policy Committee Friday decided unanimously to increase the repo rate — the rate at which the RBI lends funds to commercial banks — by 50 basis points to 5.4 per cent with immediate effect.
As it raised the rate for the third time this financial year — an aggregate of 140 basis points in three months — the RBI is set to further increase lending rates in the economy and EMIs of existing home loan customers.
RBI Governor Shaktikanta Das told reporters that the MPC has decided to remain focused on withdrawal of accommodation to ensure that inflation remains within the target going forward, while supporting growth.
While he said there are signs at this point of time that “CPI inflation has peaked and is expected to moderate going into the fourth quarter of this year and first quarter of next year,” providing the rationale behind the 50 basis point hike, Das underlined, “Inflation still remains at uncomfortably and unacceptably high level and the monetary policy has to act. There are several uncertainties that are clouding the outlook and so the monetary policy has to act and, therefore, the action of 50 basis points.”
In its statement, the RBI said that with inflation expected to remain above the upper threshold in Q2 and Q3, the MPC stressed that sustained high inflation could destabilise inflation expectations and harm growth in the medium term.
“The MPC, therefore, judged that further calibrated withdrawal of monetary accommodation is warranted to keep inflation expectations anchored and contain the second-round effects. Accordingly, the MPC decided to increase the policy repo rate by 50 basis points to 5.4 per cent,” it said.
Despite the 50 basis point hike – the second such hike in two months and an aggregate of 140 basis point hike in three months — stock markets stood strong and the benchmark Sensex at the BSE closed the day at 58,387, a gain of 89 points.
While he acknowledged that the Indian economy has been naturally impacted by the global economic situation – globalised inflationary surges, tightening of financial conditions, sharp appreciation of the US dollar and lower growth across geographies — and has been grappling with the problem of higher inflation, Das said India is expected to be among the fastest growing economies during 2022-23 (IMF’s projection) because of its strong and resilient fundamentals.
The RBI has maintained a GDP growth of 7.2 per cent for FY’23 and has projected a real GDP growth of 6.7 per cent for Q1 2023-24.
“In an ocean of high turbulence and uncertainty, the Indian economy is an island of macro-economic and financial stability. The economic growth is resilient and this is there despite two black swan events and multiple shocks,” Das said.
With the latest 50-bp hike, RBI’s policy rate is now higher than the pre-pandemic level of 5.15 per cent in October 2019. Retail inflation then was at 4.62 per cent compared with 7 per cent in June. With more rate hikes not ruled out, growth in India will also depend on the global economic prospects, which remain uncertain.
He said domestic economic activity has been exhibiting signs of broadening. If on the urban demand front there is an uptick in production of consumer durables, domestic air passenger traffic and sale of passenger vehicles, rural demand indicators have shown mixed signals.
“High frequency indicators of the services sector like railway freight traffic, port freight traffic, e-way bills, toll collections and commercial vehicle sales remained robust in June and July. Investment activity is also picking up… PMI manufacturing rose to an 8-month high in July,” he said.
He also said that capacity utilisation in the manufacturing sector has gone above its long-run average, “signalling the need for fresh investment activity in additional capacity creation.”
According to the RBI survey, capacity utilisation in the manufacturing sector in Q4 2021-22 went up to 75.3 per cent as against its long-term average of 73.7 per cent.
The central bank has also projected inflation at 6.7 per cent for the year 2022-23. Anticipating its concerns over further price increase, the RBI pointed towards incidents of unseasonal and excessive rainfall, greater transmission of input cost pressures to selling prices across manufacturing and services sectors.
“Taking into account these factors, and on the assumption of a normal monsoon in 2022 and average crude oil price (Indian basket) of US$ 105 per barrel, inflation is projected at 6.7 per cent in 2022-23,” Das said.
While the consumer price inflation has eased from its surge in April, the RBI said it remains uncomfortably high and above the upper threshold of the target.
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“Inflationary pressures are broad-based and core inflation remains at elevated levels. The volatility in global financial markets is impinging upon domestic financial markets, including the currency market, thereby leading to imported inflation,” it said.
While RBI projected an inflation of 7.1 per cent for Q2, it expects it to come down to 6.4 per cent in Q3; and 5.8 per cent in Q4. It has further projected inflation in Q1 2023-24 to be at 5 per cent. A dip in inflation hinges upon softening global commodity prices and decline in domestic edible oil prices on the back of improving supplies from key producing countries. The resumption of wheat supply from the Black Sea region, if it sustains, could help to temper international prices.
Das also pointed towards the growing trade deficit which expanded to $100 billion in April-June 2022 on account of record merchandise imports on the back of elevated global commodity prices.