RBI frontloads one more rate hike, sees inflation breaching target this fiscal

The Reserve Bank of India’s (RBI) Monetary Policy Committee (MPC) raised the policy rates by 50 basis points (bps) today, bringing the repo rate to 4.90%, standing deposit facility (SDF) to 4.65%, and marginal standing facility (MSF) to 5.15%. This is the second rate hike this fiscal, following the surprise 40 bps hike in May. Nevertheless, the repo rate is still below the pre-pandemic level of 5.15% in February 2020. The back-to-back hikes signal that inflation has been reinstated as the focus of the MPC, amid recovering growth and tightening global financial conditions.

We expect the RBI to raise rates by another 75 bps this fiscal, bringing repo rate 50 bps above the pre-pandemic level by end-fiscal. The hikes will be front-loaded this year, given heightened inflationary pressures at present. While the rate hikes will not be enough to tackle inflation, which is largely supply-driven, they could curb the second-round effects by capping excess demand and anchoring inflation expectations. Monetary policy tightening is also warranted to reduce pressure on the rupee stemming from a widening current account deficit (CAD) and capital outflows by foreign portfolio investors (FPIs).

Highlights of the June MPC meeting

• The MPC voted unanimously to raise policy rates by 50 bps, bringing repo rate to 4.90%, SDF to 4.65%, and MSF to 5.15%
• The monetary policy stance was changed from ‘accommodative’ to ‘withdrawal of accommodation’, with a unanimous vote
• The MPC raised its forecast for consumer price index-based (CPI) inflation to 6.7% for fiscal 2023 from 5.7% projected in April, with risks evenly balanced
• Projection for gross domestic product (GDP) growth was retained at 7.2% for this fiscal, with risks broadly balanced