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The stance and policy conditions still remain accommodative and the rate increase merely reversed the 40 bps repo cut delivered in May 2020”. The standing deposit facility rate is now at 4.15 percent. The RBI also decided to increase the cash reserve ratio (CRR) by 50 bps to 4.5 per cent of net demand and time liabilities, effective from the fortnight beginning May 21.
After Reserve Bank of India governor Shaktikanta Das announced an unexpected 40 basis point increase in the benchmark interest rate on May 4, stocks and bonds reacted with a knee-jerk reaction. In response to out-of-control inflationary pressures, the RBI’s Monetary Policy Committee (MPC) convened an emergency meeting and unanimously resolved to raise the repo rate to 4.4 percent with immediate effect. The repo rate is the interest rate at which the Reserve Bank of India loans money to banks for short-term needs. Even though the governor stated that “the 40 basis point rate hike today was not a movement in policy accommodation,” the interest rate decision ultimately puts an end to speculation about when the RBI would abandon its “accommodative” position.
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“The hike in CRR by 50 basis points will immediately take off Rs 87,000 crore in liquidity and about Rs 2 lakh crore due to the multiplier effect in the next 5-6 months,” said Anil Kumar Bhansali, head of treasury at Finrex Treasury Advisors. This will rein in the markets in a big way, after riding on the back of surplus liquidity.
The benchmark stock indices, which were already struggling with volatility because of global cues, responded immediately to the RBI announcement. The 30-share BSE Sensex and the Nifty 50 both plummeted 2.3 percent from the previous close. “The equity markets went into a bloodbath after the hikes since it’s a double whammy for companies,” said Abhishek Goenka, founder of IFA Global, referring to rising input costs and now higher interest rates.
Some experts had expected the rate hike, given the ever-worsening inflation in the country, aggravated by the geopolitical crisis. Wholesale prices had already risen by over 10 percent for 12 consecutive months. Inflation as measured by the Consumer Price Index was at 6.95 percent in March and was expected to accelerate over the next 2-3 months as the actual impact of higher retail fuel prices and the increase in food prices in categories such as edible oil sets in.
“Today’s surprise repo rate and CRR hikes are very well-timed as our own CPI inflation projection for April 2022 is an eye-watering 7.4 percent,” said Aditi Nayar, chief economist at ICRA. “By advancing the rate decision by approximately one month, the MPC has focused on preventing inflationary expectations from unanchoring in an increasingly uncertain environment. The committee has displayed its nimble-footedness and clearly completed the pivot back to inflation management.”
The RBI clearly laid out the rationale for increasing policy rates with this inter-meeting move, saying it was not adhering to any defined playbook and was responding to heightened uncertainty in the global backdrop.
“The large inter-meeting hike from the RBI indicates that tackling inflation risks is now front and centre and we now expect the RBI to raise the policy rate by at least 50 bps in the June policy meeting and see a near-term rate pause only around 5.15 percent,” said Rahul Bajoria, MD and chief India economist at Barclays. “Looking ahead, given the hawkish rhetoric and high likelihood of an elevated inflation print for April, the RBI will be front-loading further hikes.”
Bajoria expects the RBI to now deliver at least a 50 bps rate hike in the June policy meeting and policy rates to increase to 5.15 percent by August. The RBI is expected to reassess the macroeconomic momentum to gauge the need for further hikes beyond that. “We also believe the RBI would look to reduce liquidity in a calibrated manner and may deliver another CRR hike of 50 bps in the next MPC, but applicable only from a later date,” Bajoria added. The 10-year government bond yield surged almost 30 bps, its biggest jump in five years, after the RBI’s surprise move. At 3 pm, the 10-year bond yield was at 7.383 percent – a level last seen on May 13, 2019. The yield jumped 30 bps, its biggest gain since February 8, 2017. Bond yields and prices move in opposite directions.
“The surprise mid-cycle rate hike by the RBI is driven by factors such as inflation concern, the perception that the RBI is falling behind the curve, external sector pressures (capital outflow, higher trade deficit, weaker rupee), and the likelihood of a 50 bps rate hike by the Fed,” said Sujan Hajra, chief economist at Anand Rathi Shares & Stock Brokers. The simultaneous CRR hike would immediately tighten liquidity (by about Rs 90,000 crore), which would improve transmission of the rate hike in the credit and debt markets. “We expect an immediate increase in money market rates, some transmission in the long-term bond market and also credit market (both lending and deposit rates), while the impact on the equity market is likely to be negative in the short term,” Hajra added.
“Long-term investors need not panic at the market reaction to this move because nothing has changed with respect to the fundamentals of the economy or of good quality companies and we have seen in the past that companies that manage their costs well manage to tide over periods of high inflation and interest rates,” said Ram Kalyan Medury, founder of Jama Wealth. According to Sanjeev Hota, head of research at Sharekhan by BNP Paribas, the equity market is expected to remain volatile in the near term with range-bound volatility and will take some time to absorb the sudden policy change. Investors will also keenly monitor the outcome of the US Federal Open Market Committee meeting and its commentary.
“Notwithstanding near-term market headwinds, we continue to retain a positive view on equity over the next 2-3 years on the back of expectations of a strong bounce-back in earnings as macro headwinds subside. With pro-growth government policies, India will witness a multi-year economic upcycle,” Hota said.
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