RBI – WAR AGAINST INFLATION

RBI hiking rates today was a foregone conclusion -it was all about how much.

And the RBI decided to go all out and do whatever it can to tame inflation – a 50 bps hike in repo rate to 4.9%.

While hiking the rate aggressively, RBI retained the GDP forecast at 7.2% for FY23. The forecast includes growth of 16.2% in Q1, 6.2% in Q2, 4.1% in Q3 and 4% in Q4.

With inflation being the snake in the paradise, RBI acknowledged that inflation is likely to remain over the upper tolerance band for three quarters of the current fiscal. The inflation estimate for FY23 is at 6.7%, with Q1 at 7.5%, 7.4% in Q2, 6.2% in Q3 and Q4 at 5.8%. The inflation forecast assumes a normal monsoon and an average oil price of $105 per barrel. The Governor attributed 75% of the rise in inflation to food basket.

What this means is that we will see inflation coming down below 6% only by Jan-March 2023 and if this is the trajectory, we can safely say that we can see more rate hikes coming in this fiscal – around 85bps in total, with a probable status quo happening only by Feb. Borrowers will have to brace for rate hikes and costs going up all around. Depositors will have to wait longer to see the effect of the rate hike while borrowers will see an immediate effect – this means banks will have a much better margins going ahead till deposit rates are raised.

The MPC remains focused on "withdrawal of accommodation" to ensure that inflation remains within the target while keeping a watch on growth – a small indication of moving away from accommodative stance.

Now we need to wait and watch how the Govt compliments this aggressive rate hike of RBI. This is also the time when the Govt reviews the MSP – as per the rule book, this needs to be hike but if the MSP is increased, it will stoke inflation further. So, we need to see if the Govt follows the rules or decides to wait it out till inflation is tamed.

Other highlights:

• MSF Rate & Bank rate hiked to 5.15% from 4.65%,
• Rupay Credit Cards will be linked to UPI platforms - additional convenience to users and enhance the scope of digital payments.
• Recurring payment limit has been increased to Rs 15,000 per transaction from Rs 5,000.
• Rural cooperative banks to extend finance commercial real estate and to residential real estate projects within the limit of 5% of their total assets.
• Limits for individual housing loans extended by urban and rural cooperative banks revised upward by over 100%.
• Urban cooperative banks allowed to extend doorstep banking services.
• RBI monitoring government securities market very closely – to take necessary steps as and when required.
• The next meeting of the MPC is scheduled during August 2-4, 2022

Market moved into the positive – this is more like a relief rally, where the market heaved a sigh of relief that this is over and done with. Though on the ground, the rising crude price, the falling rupee and the oncoming US Fed meet next week will keep the markets volatile. Remember, this reaction today could be a traders response to the market, investors response could come much later.

The ECB meet tomorrow and the US inflation figures expected on Friday will be closely watched. If like India, the US inflation comes in much higher than expected, it would mean, like the RBI, the US Fed too will have to take a more aggressive stance – if this happens, we could see the markets preferring red to green. But if US inflation comes lower-then-expected, the exact opposite will happen and the markets will move up.

Remember, when interest rate cycle starts moving up, historically, money moves from equity to FDs and debt funds. This is another risk we need to contend with.

The silver lining – growth is looking good despite the runaway inflation; at least here, if normal monsoons come pouring, we do not expect any downward revision.