NEW DELHI: The Reserve Bank of India (RBI) on Friday decided to hike the repo rate by 50 basis points to 5.4 per cent and focus on withdrawal of accommodation to keep inflation within target while supporting growth.
The latest rate hike takes the policy rate back to the pre-pandemic level. Repo is the rate at which the central bank lends short-term funds to banks.
RBI also retained its retail inflation forecast for the current financial year at 6.7 percent. In its earlier policy review in June, the central bank had forecast Consumer Price Index (CPI) inflation would average 6.7 percent in 2022-23. It has however, projected CPI for the first quarter of fiscal 2023-2024 at 5 percent. While inflation declined marginally in June to 7.01 percent from 7.04 percent in May, CPI inflation has been above the medium-term target of 4 percent for 33 consecutive months. It has also been above the 6 percent upper bound of the RBI’tolerance range for two consecutive quarters.
“The MPC noted that inflation is projected to remain above the upper tolerance level of 6 per cent through the first three quarters of 2022-23, entailing the risk of destabilising inflation expectations and triggering second round effects. Given the elevated level of inflation and resilience in domestic economic activity, the MPC took the view that further calibrated monetary policy action is needed to contain inflationary pressures, pull back headline inflation within the tolerance band closer to the target, and keep inflation expectations anchored so as to ensure that growth is sustained,” said RBI governor Shaktikanta Das in a statement.
Despite global headwinds, the RBI maintained its growth forecast for FY23 at 7.2 percent. He said that the India is forecast to be the fastest-growing economy this year, as per the IMF.
Here are the keyhihglights from his speech:
The global risk
Global financial environment has deteriorated with the combined impact of monetary policy tightening across the world and the persisting war in Europe heightening risks of recession. Gripped by risk aversion, global financial markets have experienced surges of volatility and large sell-offs.
Successive shocks to the global economy are taking their toll in terms of globalised inflationary surges, tightening of financial conditions, sharp appreciation of the US dollar and lower growth across geographies.
What the global recession means for India: Emerging market economies (EMEs) have to contend with both domestic growth-inflation trade-offs and spillovers from the most synchronised tightening of monetary policy worldwide. EMEs are facing a rapid tightening of external financial conditions, capital outflows, currency depreciations and reserve losses simultaneously. Some of them are also facing mounting burdens of debt and default. Elevated food and energy prices and shortages are rendering their populations vulnerable to insecurity of livelihood.
US dollar index at a two year high: The US dollar index soared to a two-decade high in July and appreciation of the US dollar can feed into imported inflation pressures for India.
Imported inflation: Financial markets have remained uneasy despite intermittent corrections. India witnessed large portfolio outflows to the tune of US$ 13.3 billion during the current financial year. The volatility in global financial markets is impinging upon domestic financial markets, including the currency market, thereby leading to imported inflation.
Some good news: Export of goods and services together with remittances are expected to keep the current account deficit within sustainable limits. The decline in external debt to GDP ratio, net international investment position to GDP ratio and debt service ratio during 2021-22 impart resilience against external shocks.
Rupee depreciation: During the current financial year (up to August 4), the US dollar index (DXY) has appreciated by 8% against a basket of major currencies. In this milieu, the Indian Rupee has moved in a relatively orderly fashion depreciating by 4.7 per cent against the US dollar during the same period – faring much better than several reserve currencies as well as many of its EME and Asian peers.
External sector has weathered the storm: Merchandise exports grew in April-July 2022 while merchandise imports surged to record high on the back of elevated global commodity prices. Consequently, the merchandise trade deficit expanded to $ 100.0 billion in April-July 2022. Demand for services exports, especially
IT services, remained buoyant in Q1 despite global uncertainty. Exports of travel and transport services also improved in Q1:2022-23 on a year-on-year basis.
FDI is still robust: net foreign direct investment (FDI) at S$ 13.6 billion in Q1:2022-23 was robust as compared to $ 11.6 billion in Q1:2021-22.
FPI turn positive in July 2022: Foreign portfolio investment, after remaining in exit mode during Q1:2022-23, turned positive in July 2022. Along with several other measures undertaken in July, the Reserve Bank has also used its foreign exchange reserves accumulated over the years to curb volatility in the exchange rate. Despite the resultant drawdown, India’s foreign exchange reserves remain the fourth largest globally.
Normal monsoon expected this year: Domestically, RBI expects a normal monsoon this year. the southwest monsoon rainfall was 6 per cent above the long period average (LPA).Kharif sowing has also picked up.The shortfall in paddy sowing, however, needs to be watched closely, although stocks of rice are well above the buffer norms.
Industry and services holding up: High frequency indicators of activity in the industrial and services sectors are holding up. Urban demand is strengthening while rural demand is gradually catching up.
CPI eased: CPI inflation eased to 7.0 per cent (year-on-year) during May-June 2022 from 7.8 per cent in April, although it persists above the upper tolerance band. Food inflation has registered some moderation, especially with the softening of edible oil prices, and deepening deflation in pulses and eggs.
Fuel inflation still high: Fuel inflation moved back to double digits in June primarily due to the rise in LPG and kerosene prices. Core inflation (i.e., CPI excluding food and fuel) moderated in May-June due to the full direct impact of the cut in excise duties on petrol and diesel pump prices, effected on May 22, 2022, it remains at elevated levels.
Crude assumed at $105 per barrel: On the assumption of a normal monsoon in 2022 and average crude oil price (Indian basket) of US$ 105 per barrel, the inflation projection is retained at 6.7 per cent in 2022-23, with Q2 at 7.1 per cent; Q3 at 6.4 per cent; and Q4 at 5.8 per cent, and risks evenly balanced.
Other measures: Standalone Primary Dealers (SPDs) can offer all foreign exchange market-making facilities as currently permitted to Category-I
Authorised Dealers, subject to prudential guidelines. This measure will provide customers with a wider set of market makers to manage their foreign currency
risk. This will also increase the breadth of the forex market in India.
Standalone Primary Dealers (SPDs) will be permitted to undertake transactions in the offshore Rupee Overnight Indexed Swap (OIS) market with non-residents
and other market makers.