New Delhi: The Reserve Bank of India’s decision to hike the benchmark interest rate, the repo rate and the rate at which banks borrow short-term money from the RBI to meet their liquidity needs, by 25 basis points comes exactly a week after the US Federal Reserve’s decision to hike the interest rate by 25 basis points.
The US Federal Reserve was maintaining the interest rate at a near zero level at the start of the last year and then it moved swiftly to fight the rising inflation in the USA, which was hovering at a high of over 40 years. As a result, the hike of 25 basis points, which was announced early this month, was the eighth consecutive hike, which brought the policy rates to near 5%. Similarly, India’s central banker, the Reserve Bank of India, which was maintaining an accommodative stance and ultra-low interest regime to support the economy during the outbreak of the Covid-19 global pandemic, has been hiking the policy interest rates in India.
US Fed Funds rate hiked by nearly 5%
While the first rate hike effected by the US Fed Reserve in the current cycle was in March 2022 when it hiked the Federal Funds rate by 25 basis points (a quarter of a percent), lifting the funds rates from near zero to 0.25 to 0.5%. Then the US Fed hiked the Fed Funds rates by another 50 basis points in May and then it surprised the markets and economists by effecting four hikes of 75 basis points each in June, July, September and November 2022.
It brought the US policy rates from near zero in March 2022 to 3.75-4% in less than eight months. However, the US Fed did not stop here. It ended the last year with another hike of 50 basis points and on top of that it started the first policy announcement of the year with another hike of 25 basis points, which was announced on February 1 this year. This took the US policy rates (Federal Funds Rates) to the 4.5 to 5% range, from near zero rates less than a year ago.
RBI hiked policy rates by 2.5%
Similarly, in a coordinated monetary policy response, the Reserve Bank of India, which is mandated by the law to keep the retail inflation below six per cent, started to hike the policy rates in the country to fight the persistently high domestic inflation. India has been experiencing high retail inflation, which was attributed to the outbreak of the Russia-Ukraine war, high crude and other commodity prices and supply disruptions caused by the Covid-19 pandemic.
After the initial reluctance to follow the approach adopted by the US Federal Reserve, which was battling a four-decade-high inflation in the country, the Reserve Bank of India also started raising interest rates since May last year to fight India’s domestic inflation, which has been partly blamed on global factors, including high crude oil prices.
As a result, the RBI has hiked the benchmark interest rate, the Repo Rate, by 250 basis points (2.5%) since May 2022. The data suggests that due to the coordinated monetary policy actions witnessed between April 2022 and February 2023, the gap between the US Fed Funds rate and India’s Repo rate, has now declined to 192 basis points (less than two per cent).
More importantly, the gap between the US policy rates and Indian policy rates has been a constant 192 basis points since December last year and if the US Fed decides on its policy rates in March then the gap will be further narrowed if the RBI does not follow a coordinated policy in its April Monetary Policy Committee meeting.
Coordinated monetary policy leads to market volatility: SBI Research
According to State Bank of India’s Group Chief Economic Adviser Soumya Kanti Ghosh, there is evidence that synchronised rate actions have resulted in increased market volatility from pre-pandemic levels with the rate increases from April 2022, though such volatility is lower than that was observed during pandemic levels.
Soumya Kanti Ghosh said the continuous increase in Federal Funds Rate has made the monetary policy making for emerging economy central banks now a difficult proposition. Economists believe that the US Fed Reserve may not pause the rate hike after the first hike of this year, which was announced early this month.
According to Ghosh, with the US job market continuing to be significantly resilient even with the latest data, it now looks likely that the Fed rate hike could continue even beyond March. “Against this backdrop, there is an active debate on the timing and sequencing of monetary stance around the world. The exit from the current policy increases should, however, be different across countries depending on the balance of risk to growth and price stability,” Ghosh told ETV Bharat in a statement.
The economists said the April monetary policy statement of RBI would be significant as the RBI may signal its exit from a coordinated policy approach otherwise central banks of emerging economies such as India would only be doing a continuous catch up with the US Federal Reserve’s decisions.
