RBI Policy Review: Stealing the Fed’s thunder, RBI Hikes

In an off-cycle meeting, the RBI raised the policy rate by 40bps to 4.40% today. Consequently, the SDF rate was increased to 4.15% and MSF rate to 4.65%. Today’s surprise move is perhaps instigated by the upcoming April inflation print, which could come in higher than expected --- we currently estimate a print of 7.6%. The central bank justified its rate action as a step to control the second-round impact of inflationary pressures and an effort to anchor inflation expectations.

Liquidity withdrawal: The RBI also raised the CRR rate by 50bps to 4.5% which is estimated to withdraw liquidity of INR 87,000 cr. The average liquidity in the system as of April 2022 stood at INR 7.4 lakh cr. Although, the central bank continued to keep its monetary policy stance accommodative with a focus on withdrawal of liquidity over a period – providing it with some leeway in terms of supporting growth.

Bond yields – repricing effect to dominate: The bond yield curve is likely to shift up as markets price in more aggressive rate action by the RBI. While there could eventually be some value buying at the long-end of the curve – providing some comfort – for now we expect the “pricing-in” effect to dominate and push the 10-year yield to 7.5%. The bond yield curve is also likely to see some flattening with the short end rising despite surplus liquidity as future rate hikes get priced-in in the near-term. The 10-year bond yield had already risen by 27bps to 7.38% at the time of writing.

Rupee defence: Today’s policy announcement comes just ahead of the US Fed meeting today, where in the latter is expected to raise rates by 50bps and lay down the roadmap for quantitative tightening. The rate increase by the RBI puts in place a pre-emptive “traditional defence” for the rupee against capital outflows as global monetary policy tightens. The USD/INR pair was trading at 76.35 at the time of writing, appreciating by 0.22% today.

Rate outlook: The sharper than expected rate increase by the RBI today paves the way for a more aggressive rate hike cycle than we earlier expected. The renewed focus on inflation (and rising inflationary risks) makes a case for a higher terminal policy rate in this rate cycle. We expect three more rate hikes in this fiscal by the RBI now with the repo rate likely to end the year at 5.15%.

Inflation and Growth Outlook: We expect CPI inflation to average above 7% in H1 FY23 and at 6.5-6.7% for the full year FY23 with further upside risks to our forecasts. Given the rising global risks, we expect India GDP growth at 7.3% with downside risks to our forecasts.

(Mr. Abheek Barua, Chief Economist, HDFC Bank)