RBI monetary policy review: Further repo rate hikes clearly on the cards

A repo rate hike in the June 2022 policy review was a foregone conclusion after the unexpected, off-cycle rate hike of 40 basis points (bps) in May 2022, and an inflamed consumer price index-based (CPI) inflation print of 7.8 per cent for April 2022. The uncertainty was only how big the hike would be, with forecasts varying from 25-50 bps.

At Icra, we had anticipated that the Monetary Policy Committee (MPC) would raise the repo rate by 40 bps in the June 2022 policy review, in line with the magnitude of the increase seen in May 2022. However, the MPC delivered a slightly more front-loaded rate hike of 50 bps. This was a clear attempt to prevent inflationary expectations from unhinging, in the context of inflation that may be global and supply-side in its origins, but is broad-basing and is massively higher than the upper tolerance of 6 per cent.

The larger-than-expected rate hike accompanied the considerable 100 bps upward revision in the MPC’s CPI inflation forecast for FY23 to 6.7 per cent with risks broadly balanced from the 5.7 per cent projected in April 2022. This came with the clarification of an average crude oil price assumption of $105/barrel, and the caveat that the latest projection doesn’t take into account monetary policy action. Our CPI inflation forecast is similar at 6.5 per cent with an upward bias, amidst a crude oil price range of $100-120/barrel for the Indian basket.

The MPC’s quarterly inflation projections are sobering, to say the least. In spite of the measures taken by the government of India through the month of May 2022, the MPC foresees an average CPI inflation of 7.5 per cent in Q1 FY23 and 7.4 per cent in Q2 FY23, before a considerable easing to 6.2 per cent in Q3 FY23 and finally reverting below the upper tolerance level to 5.8 per cent in Q4 FY23. 

The MPC retained its growth forecast for real GDP for FY23 at 7.2 per cent, in line with our own projection. Notably, the MPC has placed its quarterly forecasts at a base-effect led sharp 16.2 per cent for Q1 FY23, plunging to 6.2 per cent for Q2 FY23, followed by anaemic prints of 4.1 per cent for Q3 FY23 and 4 per cent for Q4 FY23.

We differ in our quarterly expectations, anticipating a lower growth in Q1 FY23, given the impact of the elevated commodity prices on demand and margins. Additionally, we remain circumspect about the impact of the heatwave on wheat yields, agri GVA growth, and rural demand in Q1 FY23. At the same time, we expect a higher growth in H2FY23, partly based on our view that private capex will be back-ended, notwithstanding the higher than expected capacity utilisation of 74.5 per cent in Q4 FY22.

The Governor’s reminder that the repo rate is still below the pre-pandemic level served as a clear signal that more rate hikes lie ahead. We anticipate further hikes of 35 bps and 25 bps, respectively, in the next two policies, with a resultant repo rate of 5.5 per cent by end-September 2022. This should be followed by a longish pause to gauge whether the currently uneven growth is broad-basing.

With repo rate hikes of 60 bps expected in Q2 FY2023, why did the yield on the 10-year Government of India security (G-sec) retreat by approximately 8 bps intraday? This followed the Governor’s comment that the RBI remains focused on the orderly completion of the government borrowing programme.

With repeated cancellations and devolvement in the weekly G-sec auctions unlikely in the early part of the Government’s borrowing calendar, Operation Twist may be on the cards to cool yields. Accordingly, the up-move in the 10-year G-sec yield may now be more measured than our earlier expectations. Regardless, the bond market may remain on tenterhooks given considerable policy tightening expected from the US Federal Reserve.

The cash reserve ratio (CRR), which had been increased by 50 bps in May 2022, was retained at 4.5 per cent in June 2022. With the systemic liquidity surplus having halved already over the last two months, and transmission expected to be rapid in the rate upcycle, another CRR hike may not be needed, in our view.

Aditi Nayar is Chief Economist at Icra Limited