In an off-cycle meeting, the RBI raised the policy rate by 40 bps to 4.40%. Consequently, the SDF rate was increased to 4.15% and MSF rate to 4.65%. Yesterday’s surprise move is perhaps instigated by a couple of factors. Firstly, the 50 bps FED rate hike which came yesterday night. Secondly, the upcoming April inflation print, which could come in higher than expected around 8%. The central bank justified its rate action as a step to control the second-round impact of inflationary pressures and an effort to anchor inflation expectations.
The RBI also raised the CRR rate by 50bps to 4.5% which is estimated to withdraw liquidity of Rs. 87,000 cr. The average liquidity in the system as of April 2022 stood at Rs.7.4 lakh cr.
The US Fed FOMC increased rates by 50bps and laid down the roadmap for quantitative tightening. Thereafter the BOI increased rates by 25bps today. The rate increase by the RBI puts in place a pre-emptive “traditional defence” for the rupee against capital outflows as global monetary policy tightens.
We expect CPI inflation to average above 7% in H1 FY23 and at 63.6.5 % for the full year FY23 with upside risks to our forecasts if crude remain above $100/bbl. Given the rising global risks, we expect India GDP growth at 7.3% with downside risks to our forecasts.
The sharper than expected rate increase by the RBI paves the way for a more aggressive rate hike cycle than we expected in the last meeting itself. The renewed focus on inflation (and rising inflationary risks) makes a case for a higher terminal policy rate in this rate cycle. We expect three more rate hikes in this fiscal by the RBI now with the repo rate likely to end the year at 5.25%.
The bond yield curve is likely to shift up as markets price in more aggressive rate action by the RBI. While there could eventually be some value buying at the long-end of the curve – providing some comfort – for now we expect the “pricing-in” effect to dominate and push the 10-year yield beyond 7.5%. The bond yield curve is also likely to see some flattening with the short end rising despite surplus liquidity as future rate hikes get priced-in in the near-term. Given the expected rate hikes & reduction in liquidity we expect yields to go up further. Investors should focus on lower duration funds & floating rate funds as they will provide a hedge against increase in interest rates.
Sabyasachi Paul has been associated with equity research and advisory on equity markets in India for over 14 years & currently heads the equity research desk of Eastern Financiers Ltd, Kolkata.