Will the RBI Hike the Interest Rates?

In its last bi-monthtly meeting in February, the Indian central bank left the key lending rates unchanged. The repo rate, at which RBI lends to banks, currently stands at 4%. The reverse repo rate, at which RBI borrows from banks, is 3.35%. Photo: The Business Standard

The RBI has kept the policy rate unchanged since May 2020 and maintained its accommodative stance to ensure adequate liquidity to support growth and long-term economic recovery – though, with the threat of inflation looming large, the RBI is sure to give some indication of how to deal with it at the next meeting.

While retail inflation as measured by the Consumer Price Index (CPI) exceeded the RBI's target band of 2% - 6% in January and February, at 6.01% and 6.07% respectively, it remained within an arms length from the central bank's revised projections.

The RBI in its February statement projected inflation of 5.7% for the March, 2022 quarter and 5.3% for 2021-22. In the June policy statement, it had projected 5.1% retail inflation for 2021-22 and 5.3% for the fourth quarter.

However, there are two points here:

🌟India is importing crude from Russia. Now if we consider last year's figure then the amount is not significant. However, the GOI might change its stand and increase the quota of discounted crude. This may postpone, the immediate attack of inflation. 

If crude basket rises by 10% then that could impact CPI inflation by as much as 20 basis points, according to research house QuantEco Research. But, a headroom to adjust excise duties can delay the pass-through of the elevated global prices to pump prices. 

Now, if we reverse it due to Russian oil imports, then obviously that would have a significant impact on the inflation controlling efforts.

🌟The commodity prices are expected to rise further in the coming days due to Russia - Ukraine war, as both are having rich natural and agri resources. So, even if India can avoid Inflation due to crude oil, I feel it would be difficult to avoid the commodity trap. Hence, we need to be prepared for interest rate hikes from the later part of H2FY23.

Having said this, it would be interesting to note RBI's new normal rate for inflation, in the new financial year. If the new RBI pegs its inflation threshold (tolerance) limit above current levels then we could witnesses an entirely a different scenario.

Bottomline: Though RBI has not pushed up the rates since more than three years now, the US Fed rate hike and the oil shock could force the RBI to rethink or re - model its monetary policy.

But here also, there is a catch: The US Central bank is expected to announce multiple rate hikes this year. But with consumer spending declining as a result of higher gas prices, which could result in economic shrinkage, the Fed is likely to be more cautious before raising its interest rates, further.

Another silver lining is that RBI's deputy governor Michael Patra had a couple of weeks back hinted at continuation of pro-growth policy.

There is also an important mileu: Reserve Bank of India, also resorts to rate hikes to stop the flight of capital. If the US gives a pause to the rate hikes, India might also push its delay button.

So, at the end, the distillate comes as: The RBI in all probability is likely to keep the Repo and Reverse Repo rates unchanged, though it might signal some points or indicate some policy measures it may adopt in future to avoid hyper inflation traps.