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India: RBI hikes rates

Daniel Richards - MENA Economist
Published Date: 08 June 2022


The Reserve Bank of India (RBI) has hiked its benchmark repo rate by 50bps, taking it to 4.90%. This was more aggressive than the consensus prediction of 40bps hikes, which would have matched the hike seen in May when the central bank surprised with an intermeeting move. The RBI had until then been vocally adhering to an accommodative monetary policy as it sought to support growth and the government’s expansionary budget, but the global inflationary dynamics that have led to tightening in most central banks around the world this year have eventually necessitated action. We now forecast a further 75bps of hikes through the end of the year, taking the end-2022 rate to 5.65%, underscored by Governor Shakikanta Das’s meeting comments that the surest way to ensure growth is to preserve price stability.

Real rates in negative territory

Source: Bloomberg, Emirates NBD Research

CPI inflation in India rose to an eight-year high of 7.8% y/y in April, up from 7.0% in March and exceeding the consensus projection of 7.4%. This takes inflation nearly 2 percentage points over the central bank’s target range of 2%-6%. Key drivers of the headline gain were food and beverages inflation which was at 8.1% and transport and communication which increased by 10.9%. Wholesale inflation meanwhile accelerated to a record 15.1% y/y in April. Inflation is likely to have now peaked given favourable base effects and measures taken by the government to ease the pressure, not least the ban on wheat exports (with some exceptions including pre-agreed sales and to countries facing food security issues), increased subsidies on cooking gas for the poor and a cut on fuel duty at the pump. Nevertheless, the RBI’s communiqué acknowledged ongoing inflationary risks from a range of sources, including the pressures revealed in recent business surveys; output prices rose at the fastest pace in over eight years in May’s S&P Global manufacturing PMI for India.

Even if price growth will slow from hereon in it is likely to remain elevated given that the external drivers of inflation are unlikely to see a significant change in the near term. Indeed, the RBI’s inflation expectation for FY 2023 was raised from 5.7% to 6.7%. A major oil importer, India is especially exposed to current elevated oil prices, with the EU’s new sanctions on Russian oil having prompted Brent futures to take a leg higher once more back to the USD 120/b mark. As such, it appears that the RBI will look to prevent demand-driven price pressures becoming entrenched through more aggressive hiking action than we had previously envisaged – the statement warns of ‘potential second round effects on headline CPI’ of global price shocks, and hence the ‘need for calibrated monetary policy action to keep inflation expectations anchored and restrain the broadening of price pressures.’

USDINR hitting new lows

Source: Bloomberg, Emirates NBD Research

More aggressive hiking is especially more likely given that the Federal Reserve has upped the ante with its own hiking pipeline, with a series of 50bps hikes by the FOMC now probable. Global risk-off sentiment and the prospect of more rapid tightening than elsewhere have continued to buttress the dollar so far this year, and while the dollar index has slipped from the near two-decade highs seen in May, it has continued to strengthen against the INR which has lost -4.4% against the greenback ytd to USDINR 77.73. Higher rates could help stem the rupee’s fall and curb the pass-through inflation from further currency depreciation.