The Monetary Policy Committee (MPC) conducted an off-cycle meeting between 2nd and 4th May 2022 to reassess the evolving inflation-growth dynamics post the April MPC meeting & took the following actions:
- The RBI hiked the repo rate by 40bps to 4.40% with immediate effect consequently hiking the Standing Deposit Facility (SDF) & Marginal Standing Facility (MSF) rates to 4.15% & 4.65%, respectively. The Governor explained that this be seen as a reversal of the 40bps rate cut that took place in May 2020.
- The RBI also raised the CRR rate by 50bps to 4.50%, which is estimated to withdraw liquidity of INR 87,000 cr.
As the Russia-Ukraine conflict has dragged on, it has further created upside risks to inflation mainly through spike in commodity & food prices while macro stability for EMs like India has also been challenged through external accounts & spillovers from escalated global financial tightening. While many of these factors existed at the time of Feb’2022 & April’2022 MPC meetings, the continuity of the geo-political tensions & their ensuing impact in the near-term inflation readings probably tilted the balance towards an out of policy rate action to anchor medium term inflation expectations.
Today’s policy announcement also comes just ahead of the US Fed meeting, where the Fed is expected to raise policy rates by 50bps and detail the path for further rate hikes/quantitative tightening. As the policy divergence between the Fed & other central banks has widened, it has led to USD outperformance in recent months, although pressure on INR had been relatively stable compared to other Asian currencies year to date. The rate increase by the RBI on the day of the Fed meet probably helps place a pre-emptive “shield” for the INR against a more than expected US monetary tightening. The statement by the RBI Governor that “India is not an island in this globally connected world” reflects the shift from the domestic consideration policy approach that accentuated the Dec/Feb’2022 MPC meetings.
Outlook
As we had noted in our April policy outlook (https://www.utimf.com/articles/rbi-monetary-policy- updates-apr-22), the April policy had marked an inflection point in RBI’s reaction function which had been accommodative since June 2019 wherein the RBI for the first time has explicitly & emphatically recognized the need to anchor inflation & hence the pace & quantum of rate hikes had to be stepped up as it moved from negative real rate to a more restrictive/positive real rate framework.
Today’s action has further entrenched RBI’s priorities towards anchoring inflation expectations. As articulated in our April policy outlook, we had expected the 2-4 year segment to meaningfully flatten as market expectations moved from a gradual to a pro-active RBI.
Amidst the geopolitical uncertainty, the unexpected rate increase by the RBI today could re-price market expectations for a more aggressive rate hike cycle than earlier expected. The focus on containing inflationary expectations would possibly prepare market participants for a higher terminal policy rate in this rate cycle & an elevated term premia in case RBI lets initial transmission play out.
We were running duration at the lower band of the maturity spectrums across majority of our actively managed fixed income products & the pro-active RBI policy stance would play a dominant view in our portfolio view going forward (Being actively managed strategies, these can evolve & change at any point as per fund manager’s view).
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