Quantum of rate hike proves RBI was behind the curve

Talk of timing! The Reserve Bank of India’s (RBI) sudden move to hike repo rates by 40 bps came right on the day that the country’s biggest initial public offering (IPO) opened for subscription. The hike triggered a collapse on the Street as the benchmark indices plummeted 2.29%. Despite the bloodbath, 65% of the shares on offer of the state-owned Life Insurance Corporation of India’s got subscribed on Day 1.

But the issue here is not about LIC, as there is no doubt that the ₹21,000 crore IPO will sail through. It is about Shaktikanta Das, the RBI governor, and his team having misread the flashing red indicators all along. Jayanth Varma, professor of finance at Indian Institute of Management, Ahmedabad, has been the only dissenter in the monetary policy committee (MPC) who felt that the central bank was falling behind the inflation curve.

Varma, who has been hawkish since August 2021, had told Fortune India that keeping an accommodative stance for too long risks high interest rates in future. “By creating the erroneous perception that the MPC is no longer concerned about inflation and is focused exclusively on growth, the MPC may be inadvertently aggravating the risk that inflationary expectations will be disanchored,” Varma had mentioned at the MPC meeting last August.

Incidentally, the hike in the key rate to 4.40% came at an off-cycle meeting of the MPC on May 2 and 4. This is after the MPC had held on to the rate at its bi-monthly monetary policy review held on April 8!

Das has now justified the hike in the context of geopolitical tensions ratcheting up inflation to their highest levels in the last three to four decades in major economies while moderating external demand. “Global crude prices are ruling above $100 per barrel and they remain volatile. Global food prices touched a new record in March and have firmed up even further since then," Das pointed out.

But the landscape has not changed now; it has been since the beginning of the year exacerbated by the Russian-Ukraine conflict. The invasion had come against the backdrop of a four-decade high inflation in the U.S., where retail prices rose 7.9% in February 2022. In fact, the U.S. Federal Reserve had not only hiked interest rates by 0.25% in March but also hinted at more hikes in the future. Closer home, inflation has been on the boil owing to supply-side disruption, which was aggravated further by the two-nation conflict. In fact, food prices have been heading north since October 2021 with the Consumer Food Price Index having risen 14 times (month-on-month). Wholesale prices, as measured by the wholesale price index, surged to 14.5% in March, while retail inflation, as measured by the Consumer Price Index, hit 6.95% in March 2022.

However, according to Suyash Choudhary, head-fixed income at IDFC, when looked at cumulatively, and backed with now a firm eye on evolving inflation dynamics, the RBI actually comes across as a very ‘on-ball’ central bank especially when measured against some of its developed market counterparts.

He, however, qualified the observation by stating that the governor’s statement has created uncertainty about the rate trajectory going ahead. The governor in the statement has mentioned that “in response to the pandemic, monetary policy had shifted gears to an ultra-accommodative mode, with a large reduction of 75 basis points in the policy repo rate on March 27, 2020, followed by another reduction of 40 basis points on May 22, 2020”.

The comment could possibly be construed as the MPC being open about hiking the rate by another 75 bps, and still characterising themselves as being in the process of withdrawal of accommodation. “While strictly speaking they may be correct, this still serves as one more trigger for confusing market expectations; ironically probably having the exact reverse effect of what the statement may have intended to achieve,” feels Choudhary.

The flip side to rate hike is that it has the potential to attract overseas flows as foreign investors have been fleeing Indian shores with the country’s forex reserves having fallen by $32 billion in two months to $600.42 billion (April 22) since the Russian conflict began in February.

In the April 8 statement, Das had mentioned that the “we have demonstrated over the last two years, we are not hostage to any rulebook and no action is off the table when the need of the hour is to safeguard the economy.” But the jury is still out whether the RBI’s action will indeed safeguard the economy or whether it came in a tad too late.