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Rbi on the front foot with a 50 bps hike, keep all options open

The RBI today made a sharp hike of half a percentage point in the repo rate, taking the rate to its highest level since August 2019. With this, the RBI raised the repo rate by 140 basis points in just 3 months (since May 4) — probably the fastest rate of rise in decades — although much less than other central banks like the US Federal Reserve. The rate hike was clearly at the upper end of expectations and pushed bond yields up more than 15 basis points from their pre-policy level of 7.12%.

Politics Today was notable for some distinct tonal shifts:


For the first time, the governor’s statement included detailed data on the external sector. He correctly noted the huge increase in imports and the expansion of the trade deficit to $100 billion in four months. He calmed the market by pointing to the robustness of IT services exports and also provided data on FDI and FII flows to prove that the current account deficit is financed. This detailed reflection on the external sector seems to indicate that the RBI preferred a 50bp hike to 35bp hike due to a need to show support for the rupee, even though the rhetoric for targeting pure inflation are maintained.

2. The second fundamental change in the policy document was the theme that growth has arrived. There was no reference to the “recovery” of the economy. In fact, the governor presented a series of indicators such as rail freight traffic, port freight traffic, electronic way bills, toll collections, commercial vehicle sales, credit growth and the rise of the PMI to show that growth is robust. The most telling data he bothered to elaborate on was that capacity utilization in manufacturing at 75.3% is now above its long-term average of 73.7%. It was clear that the RBI thinks the output gap has closed, although when asked if he thinks inflation is now also demand-driven, the Governor sticks to the old logic of supply problems. The final giveaway on growth was his statement that stable growth has given RBI the space to raise rates and tackle inflation.

3. A third important point to note is that the governor had previously said that the RBI’s inflation forecast of 6.7% for this year did not include gains from rate hikes. This phrase has been conspicuously absent from current policy, giving the impression that the RBI is probably worried that inflation will not come down that much. The one-year inflation forecast for the first quarter of FY 2023-24 has therefore been set at 5%, despite a high base a year ago.

4. Finally, the RBI has absolutely refused to be dragged into indications of when it will achieve positive real rates – whether it is preloading or close to its neutral rate. The governor has been firm, and rightly so, that there is too much uncertainty for such guidelines.

The market is of the opinion that a rate hike is surely to come in October, given that inflation, even in October, will be above the upper limit of the range of 2 to 6% of the Monetary Policy Committee and even a year later will be above the mandate of the MPC. 4% target. All in all, great policy and appropriate accompanying statements – letting the RBI’s leeway move slowly or quickly, depending on the global situation. Today’s round goes to the RBI!

First post: STI


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