New Delhi: The Reserve Bank’s policy of keeping the benchmark interest rates low while maintaining the accommodative stance to boost liquidity in the financial system might just change in two months from now as the retail inflation hit 7 per cent in March this year. It will be a difficult call for the six-member monetary policy committee when it meets again in June this year, the second meeting of the current fiscal. It is largely because the headline CPI inflation picked up sharply in March which is mostly driven by sharp increases in food and core inflation, which is taking a structural shape.
Priyanka Kishore, Head of India and South East Asia at Oxford Economics, says the think tank has already highlighted the possibility that inflation would rise to 7% for some time and it sees little reason for price pressures to ease substantially in the near term. She says that the think tank maintains its forecast of a 25 basis repo rate hike in June. "Despite retaining an accommodative stance at the April 8 policy meeting, the RBI revised up its FY23 inflation forecast substantially and narrowed the policy corridor by 40 basis points, underlining a shift in its focus to inflation," she said in a statement sent to ETV Bharat.
The six-member monetary policy committee (MPC) which met for two days on April 6 and 7 this month, decided to maintain the repo rate at 4% and reverse repo rate at 3.35% despite expectations of a rate hike to tame the high inflation which was more than 6% in February, the upper tolerance band set by the government for the RBI. Though Oxford Economics has maintained its forecast of a 25 basis point hike in repo rate in the June meeting, another economist, Sunil Sinha of India Ratings believes that there is a scope for a 50 basis point hike in repo rate.
The repo rate is the short-term benchmark inter-bank lending rate at which banks borrow money from the RBI and the reverse repo rate is the benchmark interest rate at which banks park their surplus funds with the Reserve Bank. RBI has several reasons to reverse the cycle by upwardly revising the repo rate in June this year. For one, headline inflation accelerated to 6.95% on a year-on-year basis in March this year. It had increased by 6.07% in February this year as against the CPI during the same month last year. The main reason behind the elevated inflation was a rise in food prices as food inflation jumped from 5.9% to 7.7%.
Read: Explainer: What is pushing India's retail inflation?
Core-of-the-core inflation, which is basically CPI excluding food, fuel, and motor fuels, also increased to 6.2% from 5.6% though there was some moderation in fuel inflation as it moderated to 7.5% from 8.7% in February. "Inflation has climbed to 7% slightly earlier than we expected, but we still think inflationary pressures will remain elevated in the near-term amid delayed passthrough of global price increases," Priyanka Kishore wrote in a note. Kishore says with energy and food inflation likely to continue rising into Q3, the think tank anticipates a spillover impact on core inflation as well and after that, it expects a slow downtrend due to lingering supply-side issues.
"In all, this strengthens our view that monetary policy tightening will kick off in June, and that the RBI could tighten by more than the 50 basis points we expect this year," she observed. Some other economists also believe that the Reserve Bank will increase the repo rate by 50 basis points this year. It means that the cost of borrowing money for banks and NBFCs will increase and it will have a pass-through impact on loans taken by bank customers, particularly the retail customers who borrow money from banks for buying homes, automobiles and other such expenditures.
The RBI is legally mandated to keep the retail inflation at 4% with an upper and lower tolerance of 2 per cent on each side. The RBI is required to explain the reasons to the Parliament if it fails to maintain the retail inflation within prescribed limits for a consecutive period of three quarters. In the last week’s MPC meeting, the RBI revised its FY 2022-23 inflation forecast to 5.7% from its earlier forecast of 4.5%. The RBI also introduced a Standing Deposit Facility rate as the new floor of the policy corridor at 3.75%. This is 40 basis points above the previous floor.
Priyanka Kishore, who closely tracks macroeconomics in India and in South East Asian countries, says these are signs that the Reserve Bank’s policy normalisation is beginning in earnest. "While the recovery is on a less sure footing, as underlined by another month of muted industrial production growth (1.7% year-on-year in February), we think that delaying monetary tightening will only result in greater macro-financial risks eventually," she wrote in the report. She further adds that inflation is likely to stay above the RBI's target range throughout this year and the actual FY23 inflation outcome could be even higher than the RBI's forecast at 6.9%.
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