The Reserve Bank of India’s Monetary Policy Committee (MPC) on Wednesday raised the policy repo rate by 25 basis points to 5.50 per cent, as escalating energy costs, rising food prices and heightened global financial market volatility increased inflationary risks.
The six-member rate-setting panel unanimously voted to increase the policy repo rate under the liquidity adjustment facility (LAF) by 25 basis points. Consequently, the Standing Deposit Facility (SDF) rate has been adjusted to 5.25 per cent, while the Marginal Standing Facility (MSF) rate and the Bank Rate have been raised to 5.75 per cent.
The MPC also decided by a majority to change its monetary policy stance to “calibrated tightening”, signalling a shift in the central bank’s policy approach as it seeks to contain emerging inflationary pressures.
Announcing the decision after the MPC’s three-day meeting held from October 5-7, RBI Governor Sanjay Malhotra said the committee undertook a detailed assessment of evolving macroeconomic and financial conditions and the outlook before deciding on the policy action.
The rate hike comes amid a deterioration in the global inflation outlook, driven by escalating energy costs and rising food prices.
Malhotra noted that while global economic growth remains resilient, it is projected to decelerate this year compared with the previous year.
Why the rate hike
The MPC’s decision to raise the repo rate was driven by a less benign inflation outlook despite the resilience of the Indian economy.
Malhotra said the Indian economy remains strong, with economic momentum broad-based, and is expected to remain resilient despite a challenging global environment marked by geopolitical tensions.
However, the MPC noted that inflation and its outlook are no longer as benign as they were last year. Headline CPI inflation is expected to average around 5.8 per cent over the next three quarters, including the current quarter, while inflation for the full financial year is projected at 4.4 per cent.
Against this backdrop, the MPC said recalibrating the policy rate had become imperative.
The central bank’s concern is not only the immediate impact of supply-side shocks but also the risk that these pressures could become embedded in inflation expectations and firms’ pricing behaviour.
The RBI noted that monetary policy primarily works by containing the second-round effects of supply-side inflation. These include changes in inflation expectations and firms’ pricing behaviour, which can take time to emerge and can be difficult to isolate from available data.
To assess the extent to which inflation is becoming broad-based, the MPC also looks at indicators such as core inflation and inflation diffusion indices. However, the RBI cautioned that these indicators can capture both second-round effects and the indirect impact of supply-side pressures, particularly those arising from higher energy and other input costs.
The MPC observed some evidence of elevated inflation expectations and a generalisation of inflation, although there were limited signs so far of supply-side pressures becoming embedded in firms’ pricing behaviour.
At the same time, the central bank said there was limited evidence of demand-side inflationary pressures. However, it flagged risks arising from strong economic growth and monetary and credit aggregates.
Taken together, the MPC judged that the balance of risks warranted a recalibration of monetary policy. It therefore unanimously voted to raise the repo rate by 25 basis points to 5.50 per cent.
Malhotra said that, under current conditions, rate cuts are off the table in the near term, with future policy action likely to be either a rate increase or a pause depending on how inflation, growth and other macroeconomic conditions evolve.
Rate hike was increasingly on the cards
Expectations of a policy rate increase had strengthened ahead of the October MPC meeting as the inflation environment turned less benign and global monetary conditions tightened.
Higher crude oil and other energy prices have raised concerns over input costs across manufacturing, transportation and logistics, while rising food prices have added to headline inflationary pressures.
The shift towards monetary tightening by major global central banks also complicated the RBI’s policy calculus. Higher interest rates in advanced economies and rising bond yields can trigger capital outflows from emerging markets and put additional pressure on their currencies.
A stronger dollar adds another layer of inflationary risk for India by making dollar-denominated imports, including crude oil, more expensive.
