The Reserve Bank of India (RBI)’s Monetary Policy Committee raised the policy rate by 0.5 percentage points on Friday, and issued a statement that was remarkable for its hawkishness. RBI has now increased the policy rate by 1.4 percentage points since May — a pace that is uncharacteristic for a central bank that is usually not in favour of sudden and uncalibrated moves that can spook markets, unsettle investors, and affect growth.
Since RBI left its growth estimate for the year 2022-23 unchanged at 7.2%, and its retail inflation (as measured by the Consumer Price Index) estimate unchanged at 6.7%, it is clear that it sees managing inflation as the bigger challenge at this point — and that it does not expect growth to be affected in any material way by the rate hikes. It is also evident that RBI has decided to play it safe, especially in anticipation of volatility in international energy markets — winter in the northern hemisphere is usually associated with higher energy demand, and there is no sign of the Russia-Ukraine conflict ending. The price of India’s energy basket has come off its peaks, but is still above $100 for a barrel of crude — way above the assumption made in the Union budget.
Three questions arise from RBI’s interest rate hike, and the tone of its accompanying statement. One, how much longer will the current rate tightening cycle last? And, by extension, what will the policy rate peak at? All signs indicate that the cycle could last for the rest of this calendar year, although most experts expect the quantum of future rate hikes to be smaller. Experts also predict that the rate could peak anywhere between 5.7% and 6% — the policy rate is currently at 5.4% — which means RBI has actually already effected much of the increase in this cycle. Two, what will the impact of this increase be on growth? After all, the rest of the world is slowing down. Friday’s rate increase takes the policy rate to a level last seen in August 2019, which means that mortgage rates — lenders are always quick to transmit rate hikes — will now rise to pre-pandemic levels. It is likely that this could take a toll on demand, especially from the critical consuming classes, and ahead of the all-too-critical festive season. RBI is sure to have considered all this. Still, given the limitation of interest rate hikes in controlling inflation caused by supply chain disruptions and global price volatility, the lingering third question is whether it has done a little too much?
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