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Out-of-turn MPC meeting stirs markets

Policy repo rate hiked by 40bp to 4.4%

In an unexpected move, the RBI held an out-of-turn monetary policy meeting on 2nd and 4th May’22 where it decided to hike the policy repo rate by 40bp to 4.4%. Consequently, the Standing Deposit Facility (SDF) now stands at 4.15% and the Marginal Standing Facility (MSF) at 4.65%. This is the first rate action by RBI since May’20. Its accommodative stance, however, has been kept unchanged. Both decisions – hiking the policy repo rate and keeping the stance unchanged – were unanimous.

In line with the Apr’22 announcement of a gradual withdrawal of liquidity, RBI decided to increase the Cash Reserve Ratio (CRR) by 50bp to 4.5% of NDTL, effective from the fortnight beginning 21st May’22. This will suck out INR870b worth of liquidity from the market.

While the decision on hiking rates was definitely a surprise, the rationale behind the move has been known for a few months now. These include: 1) geopolitical tensions inflaming high global inflation in crude oil, food, and edible oil; 2) unwinding of the quantitative easing in advanced economies; 3) COVID-related lockdowns and restrictions, which may accentuate the bottlenecks in the global supply chain.

Given that a) inflationary pressures have existed for at least two quarters now, b) geopolitical tensions have made matters worse since the end of Feb’22, and c) economic growth is still at a nascent recovery stage, RBI’s decision was either a month too late or soon. Naturally, the financial markets were spooked, with bond yields hardening by ~25bp to 7.37% and the equity market closing ~2% lower. Therefore, we believe conducting an off-cycle meeting was uncalled for.

Moreover, hiking policy rates and keeping its macroeconomic outlook unchanged from the Apr’22 (scheduled) MPC meeting, without changing projections, is confusing. Going forward, we believe that reduction in FY23 real GDP growth forecast is in the anvil. Currently, our forecast of real GDP growth for FY23 is 6.4% YoY, lower than the market consensus of 7.5% YoY and RBI projection of 7.2% YoY.

I. Off-cycle MPC meeting announcement

Policy repo rate raised to 4.4%...: In an unexpected move, the RBI on 4th May’22 hiked the policy repo rate by 40bp to 4.4%. Consequently, the SDF now stands at 4.15% and the MSF/bank rate at 4.65%. This is the first rate action by RBI since May’20. Accordingly, RBI termed it as “reversal of the rate action of 22nd May’20” when it had slashed the policy repo rate by 40bp to 4%. Its accommodative stance, however, has been kept unchanged. Both decisions – hiking the policy repo rate and keeping the stance unchanged – were unanimous.

…on the back of inflationary headwinds: While the decision on hiking rates was definitely a surprise, the rationale behind the move has been known for a few months now. These include: 1) geopolitical tensions inflaming high global inflation in crude oil, food, and edible oil; 2) unwinding of the quantitative easing in advanced economies; 3) COVID-related lockdowns and restrictions, which may accentuate the bottlenecks in the global supply chain

CRR too was hiked by 50bp to 4.5%: In keeping with its stance of withdrawal of accommodation and in line with the Apr’22 announcement of a gradual withdrawal of liquidity over a multi-year time frame, RBI decided to increase the CRR by 50bp to 4.5% of NDTL, effective from the fortnight beginning 21st May’22. This will suck out INR870b worth of liquidity from the market.

II. Outlook for inflation and growth remains unchanged

Food inflation pressure likely to continue…: Just like in its Apr’22 MPC meeting, the RBI continues to expect greater inflationary pressures on account of higher food prices. Besides food inflation, the direct impact of higher pump prices on petroleum products may take core inflation also higher up. Various indications such as higher food index of the Food and Agriculture Organization (FAO), global wheat shortages, firming up of edible oil prices, elevated feed cost taking poultry prices higher, crude oil price hovering ~USD100/bbl, and risks of higher input cost pressure strengthen inflationary impulses, as per the RBI.

…and domestic economic activity is increasingly broad-based: The RBI feels recovery in India’s economic activity is becoming increasingly broad-based. Factors such as an improvement in private consumption, forecast of a normal monsoon, revival in investment as reflected in better capital goods production, and rising capital utilization led the RBI to turn slightly positive on growth. However, headwinds from global spillovers may continue to pose downside risks to growth.

III. Implications of the surprise move

Off-cycle MPC meeting uncalled for as nothing has changed in a month: Given that a) inflationary pressures have existed for at least two quarters now, b) geopolitical tensions have made matters worse since the end of Feb’22, and c) economic growth is still at a nascent recovery stage, RBI’s decision was either a month too late or soon. Naturally, the financial markets were spooked, with bond yields hardening by ~25bp to 7.37% and the equity market closing ~2% lower. We believe conducting an off-cycle meeting was uncalled for.

A cut in its real GDP growth forecasts on the anvil: Hiking policy rates and keeping its macroeconomic outlook unchanged from the Apr’22 (scheduled) MPC meeting, without changing its projections, is confusing. Currently, our forecast of real GDP growth for FY23 is 6.4% YoY, lower than the market consensus of 7.5% YoY and RBI projection of 7.2% YoY. Going forward, we believe that the real GDP growth forecasts for FY23 may be reduced across market segments.

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