RBI MPC Aug'22 Preview: Where will the MPC Tilt - a Hike of 35bps or 50bps?

04 Aug 2022

RBI has a tough choice to make this week between continuing with a 50bps repo rate hike (as in June) and a more calibrated 35bps hike while navigating the crosscurrents of inflation and recession. Retail inflation which the RBI takes as a reference for its policy review stands at 7.01%. (RBI Tolerance band is 2%-6%). Citi analysts argue that the MPC would opt for a ~35bps hike at the August meet given some easing of inflationary pressure since the last meet. They believe the “withdrawal of accommodation” stance might continue but central bank will place emphasis on data-dependence rather than explicit forward guidance. What is the argument for each? Where will the MPC tilt? Key details appended below:

• 1. Factors Favoring a 35bps Rate Hike: There is easing Inflationary pressure. Headline inflation in the June-quarter (7.3%YY) is below the RBI forecast (7.5%YY) and RBI may lower its FY23 average CPI forecast to 6.7%. The daily index suggests that tightness in financial conditions is already close to the 2018 high with the repo rates remaining low relative to historical levels. RBI’s preferred operative rate is the weighted average call rate which had moved from below the Standing Deposit Facility (SDF) rate (or the reverse repo rate) to the middle of the corridor in mid-July and for the last week has been above the repo rate. Given the data dependency for forward guidance - a 35bps hike might give MPC the much-needed two-way flexibility i.e. If Inflation rises, MPC would still be able to move towards larger hikes in 2H 2022. If Inflation eases then a 35bps hike may act as a bridge towards a more normal 25bps hikes in the future.



• 2. Factors Favoring a 50bps Rate Hike: Keeping real rates negative for too long raises credibility risk for RBI’s inflation targeting mandate. Additionally, the differential between India-US monetary policy rates spread have been pushed down to ~250bps and post the recent Fed hike, from ~600bps in May-2021. Managing this interest rate differential with 50-60bps repo rate hike in August might ease off some pressure from USDINR and the falling FX reserves. Citi analysts believe there could be an urgency to move closer to 5.5% on repo rate, which is often considered to be the Neutral Rate for the RBI.

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