RBI Shifts Gears to Tame Inflation: Commences Monetary Tightening

05 May 2022

The Reserve Bank of India in a surprise move raised the repo rate by 40bps (after nearly two years) to 4.4% on 4th May’22 while also increasing CRR (cash reserve ratio) to combat rising inflation. All six MPC members unanimously voted to remain accommodative albeit remaining focused on withdrawal of accommodation to ensure inflation remains within the target range. MPC’s statement on Inflation implies an acceptance of the likely breach of redline (three consecutive quarters of above 6% inflation). With this unscheduled U-turn to raise interest rates MPC seems ready to tolerate a higher growth sacrifice to rein in inflation. Citi analysts expect 10Y yields to move towards 8% mark in FY23.

Key Points Appended Below:

• 1. Inter Meeting Hike: RBI MPC has unanimously decided to hike repo rates by 40bps in an unscheduled meet on 2-4 May 2022 (next scheduled meet on 6-8 Jun). Stance remains accommodative with focus on “withdrawal of accommodation”. MPC sees today’s decision to hike rates as reversal of its action in May-2020.
• 2. Inflationary Risk: RBI has highlighted risk of continued food inflation pressure through edible oils and elevated food cost. RBI Governor’s statement of “upward risks to the inflation trajectory presented in the April MPC” implies an acceptance from RBI of likely breach of redline (three consecutive quarters of above 6% inflation). The revised inflation forecast at the next meet (8 Jun) might peg Sep-22 quarter above 6% from current forecast of 5.8% (Citi view: 6.4%).
• 3. Rate Hike Trajectory: RBI expects Terminal repo rates at around 6% (5.5% earlier) as real rates might have to stay above long-term equilibrium levels (~100bps). Citi analysts expect a 35bps hike at Jun-22 meet and further five consecutive 25bps hikes until April-23.



• 4. Reining in the inflationary impulse from liquidity surplus: The CRR hike of 50 basis points to 4.5% will help absorb ~INR 870bn of excess liquidity. Citi analysts believe with the current monetary policy stance justifying OMO purchases looks difficult and the possibility of operation twist kind of measures now looking less likely in the near term. The current rate hike cycle will have an added constraint of significant liquidity normalization, which could keep the term premia elevated. This could take 10Y bond yields towards the 8% mark in FY23

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