RBI shocks markets with lending rate hike before US Federal Reserve’s decision

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India’s central bank raised its key interest rate and moved to drain liquidity from the banking system in a surprise move Wednesday, sending bonds and stocks crashing, as it intensified the battle against inflation that’s outpaced its expectations this year. 

In its first unscheduled rate change since the depths of the pandemic, the Reserve Bank of India increased its repurchase rate to 4.40%, from the record low 4% its been held at for the past two years to support the economy. 

Persistent inflation pressures are becoming more acute, particularly on food, Governor Shaktikanta Das said in an online briefing, adding that there is a risk prices stay at this level for “too long” and expectations become unanchored. 

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“Inflation must be tamed in order to keep the Indian economy resolute on its course to sustained and inclusive growth,” Das said, adding that input costs pressures were becoming “more potent” than before. 

The central bank also increased the cash reserve ratio by 50 basis points to 4.5%, which will force lenders to park more money with the central bank and leave them with less to loan to consumers. Das said that would drain 870 billion rupees ($11.4 billion) of liquidity from the banking system. 

“The RBI is telling us its all-hands-on-deck as far as inflation management is concerned,” said Rahul Bajoria, an economist with Barclays Plc in Mumbai.

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Yields on the benchmark 10-year bond jumped as much as 30 basis points to 7.42%, the highest since 2019, while the main stocks index fell to a near two-month low. The rupee was up 0.1%, the second best performer in Asia for the day, as the higher rates lent the currency some additional support.

RBI policymakers had recently begun signaling that higher rates were in the works, after drawing fire from some economists for being too slow to react as consumer prices breached the upper limit of the bank’s target through the first quarter of 2022.

The move also comes ahead of the Federal Reserve’s rate decision on Wednesday, which is expected to see the U.S. central bank’s most aggressive action to battle inflation in decades.

Increases in fuel and food prices, exacerbated by Russia’s invasion of Ukraine and sustained pandemic-related supply chain disruptions, have run hotter than the RBI had expected. Headline inflation in March rose to a 17-month high of 6.95%, riding above the RBI’s 2%-6% target range for a third month. 

After reaffirming its accommodative stance in February — a step criticized by some economists as too benign on the risk of rising prices — the central bank said last month that it would begin prioritizing inflation over supporting growth. 

“This is precisely in line with stance of withdrawal of accommodation” that was announced last month, Das said of Wednesday’s out-of-cycle decision. The bank’s next scheduled rate decision isn’t until June 8.

Das also warned that pressures on food inflation will continue, citing a tight global wheat market and rising edible oil prices, as well as rising retail fuel costs. 

“This is a very well timed move,” said Aditi Nayar, chief economist ICRA Ltd., adding that by advancing the rate decision by approximately one month, the Monetary Policy Committee has focused on anchoring inflationary expectations in an increasingly uncertain environment.

In an interview late last month, Jayanth Rama Varma, one of the most hawkish members of the RBI’s rate-setting committee, signaled that the bank was ready to increase borrowing costs. “All the groundwork has been laid,” he said. “The liquidity normalization has happened, the forward guidance has been dropped, we are now completely free to act.”

Another member of the MPC, Shashanka Bhide, said in a separate interview that policymakers had been “a little surprised” by the rise in food prices. 

The RBI in April raised its inflation forecast to 5.7% for the fiscal year that started April 1, up from its 4.5% in February, and said it sees gross domestic product growth during the year at 7.2%, compared with a previous expectation of 7.8%.



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