RBI shocker: Raises rates by 40 basis points; markets slump. All you need to know

The Reserve Bank of India (RBI) on Wednesday shocked the markets with a surprise 40-basis-point increase in benchmark repo rates to control spiralling inflation, but kept its monetary stance accommodative.

After an unscheduled monetary policy meeting, the central bank increased the rate at which it lends to banks to 4.40% from 4%.

Consequently, the standing deposit facility rate stands adjusted to 4.15% and the marginal standing facility rate and the Bank Rate to 4.65%, the RBI said.

The surprise move comes barely a month after the RBI kept interest rates unchanged at its policy meeting in April for the 11th consecutive time since May 2020, when the key lending rate was cut to a historic low of 4%. 

The RBI said that rising inflation remains a worry as retail inflation rose to almost 6.95% in March 2022, while wholesale inflation raced to 14.5%. 

Aside from raising rates, has the RBI changed its policy stance?

Not yet. The monetary policy committee decided to remain accommodative but instead focus on withdrawal of accommodation to ensure that inflation remains within the target while supporting growth.

But why did the RBI raise interest rates so soon after the April meeting?

The RBI noted the acceleration in headline CPI inflation in March and said it largely reflected the impact of geopolitical spillovers. “The rapid rise in inflation is occurring in an environment in which inflationary pressures are broadening across the world,” it said.

Since the April meeting, disruptions, shortages and escalating prices induced by the geopolitical tensions and sanctions have persisted and downside risks have increased, the RBI said.

The central bank noted that the International Monetary Fund has revised down its forecast of global output growth for 2022 while the World Trade Organization has scaled down projection of world trade growth for 2022 by 1.7 percentage points to 3%.

At home, economic activity in India stabilised in March-April with the ebbing of the third wave of COVID-19 and the easing of restrictions. Urban demand appears to have maintained expansion but some weakness persists in rural demand, the RBI said.

The RBI also said that investment activity seems to be gaining traction and merchandise exports recorded double-digit expansion for the fourteenth consecutive month in April.

Overall system liquidity remained in large surplus, the RBI said. Bank credit rose 11.1% as on April 22, 2022.

Who all voted in favour of the rate hike and keeping the policy stance unchanged?

All members of the MPC –Shashanka Bhide, Ashima Goyal, Prof. Jayanth R. Varma, Rajiv Ranjan, Michael Debabrata Patra and Shaktikanta Das – unanimously voted to increase the policy repo rate.

All members also unanimously voted to remain accommodative while focusing on withdrawal of accommodation.

What is the RBI’s outlook for inflation and economy?

The RBI said that heightened uncertainty surrounds the inflation trajectory, which is heavily contingent upon the evolving geopolitical situation. Global commodity price dynamics are driving the path of food inflation in India.

International crude oil prices remain high but volatile, posing considerable upside risks to the inflation trajectory through both direct and indirect effects. Core inflation is likely to remain elevated in the coming months, reflecting high domestic pump prices and pressures from prices of essential medicines. Renewed lockdowns and supply chain disruptions due to resurgence of COVID-19 infections in major economies could sustain higher logistics costs for longer. All these factors impart significant upside risks to the inflation trajectory, the central bank said.

As regard the outlook for domestic economic activity, the forecast of a normal southwest monsoon brightens the prospects for kharif production, the RBI said. The recovery in contact-intensive services is expected to be sustained, with the ebbing of the third wave and the growing vaccination coverage.

The RBI said investment activity is likely get an uplift from robust government capex, improving capacity utilisation, stronger corporate balance sheets and congenial financial conditions.

On the other hand, the worsening external environment, elevated commodity prices and persistent supply bottlenecks pose formidable headwinds, along with volatility spillovers from monetary policy normalisation in advanced economies.

On balance, the Indian economy appears capable of weathering the deterioration in geopolitical conditions but it is prudent to continuously monitor the balance of risks, the RBI said.

How have the markets reacted to the central bank’s policy statement?

The markets were deep in the red. The benchmark BSE Sensex was down about 1,374 points, or 2.4%, to 55,600 points in late afternoon trade. The NSE Nifty was also down 2.43% to 16,653 in late afternoon trade.