RBI hikes repo rates by 50 bps, no change in CRR

The June 2022 monetary policy was presented in the middle of a lot of expectations and a lot of assumptions. Global economy is in a state of flux, inflation is still elevated and supply chain constraints continue to plague GDP growth.

It is in this light that the RBI presented the June 2022 monetary policy. It was a tough ask. RBI had to control inflation without compromising on growth. That is easier said than done. Also, it had to ensure that monetary policy did not diverge too much from the global stance, as it would trigger capital outflows.
 

Here is what the RBI policy said in June 2022

1. The repo rate was hiked by the RBI by 50 basis points (0.50%) from 4.40% to 4.90%. It may be recollected that the RBI had already hiked the repo rates by 40 bps to 4.40% in its special May MPC meet. Repo rates at 4.90% are still 25 bps short of the pre-COVID levels of 5.15%. That means; even reversal is not done with.

2. There are several rates in the economy that are pegged to the repo rate and hence move in tandem. The standing deposit facility (which replaced the reverse repo) stands increased by 50 bps from 4.15% to 4.65%. At the same time the MSF / Bank Rate also stands increased by 50 bps from 4.65% to 5.15%.

3. Why did the RBI opt to give CRR hike a miss. The CRR stays at 4.5% and this was something that SBI had projected in its pre-policy report. Most banks had been demanding a status quo on CRR as a hike in CRR would put a huge pre-emption charge on the banks. RBI felt that VRRRs were good enough to absorb liquidity in the system.

4. The big news was on inflation expectations for FY23. It was raised by 100 bps from 5.7% to 6.7%. In the last couple of months, the RBI has shifted its estimate of inflation for FY23 higher by 220 bps from 4.5% to 6.7%.

However, the GDP forecast for FY23 was maintained at the extant level of 7.2%. RBI expects that a normal monsoon should give a boost to revival rural demand and have a positive impact on growth. The RBI estimates of GDP growth at 7.2% are 30 bps more conservative than the World Bank estimates.
 

5. What about the vote of the members on the rate hike and the stance. All the six members of the MPC voted unanimously to hike the repo rates by 50 bps to 4.90%.

There was also total consensus among the members of the MPC to stay focused on withdrawal of accommodation. The idea was to keep growth levers moving while keeping inflation in the range of 4% with 200 bps leeway either ways

6. How is the inflation projection of 6.7% for FY23 broken up quarter wise. The break-up is as under: Q1FY23 at 7.5%, Q2FY23 at 7.4%, Q3FY23 at 6.2% and Q4FY23 at 5.8%. However, there are two sets of assumptions that could offset each other.

On the one hand, RBI has assumed $105 as the benchmark cost for crude basket in India. It could be lower if Russian discounted crude is factored. There is also the assumption of normal Kharif and southwest monsoons. However, the policy impact is not factored so it could more or less offset the inflation risks from current levels.

7. Finally, let us look at how the inflation projection of 7.2% for FY23 is broken up quarter wise. Here is how it goes: Q1FY23 at 16.2%, Q2FY23 at 6.2%, Q3FY23 at 4.1% and Q4FY23 at 4.0%. Clearly, there is a lot of front loading of growth due to the weak base effect.

RBI is betting on the GDP to be normal as indicated by the high frequency indicators like GST collections, PMI data, freight and e-way bills. Also, the rural consumption is expected to turn around in sync with a strong Kharif output.

In short, the RBI is positive on growth, but cautious on inflation. That is reflected in the policy. However, the RBI may still have concerns over the liquidity in the system as the daily liquidity absorption in May 2022 was nearly Rs.2 trillion lower than in April.

For now, the RBI has more than matched the 75 bps rate hike by the Fed in the last 2 meetings. The June Fed meeting  would be an important data point for future course of action by the RBI.