Eye on inflation, RBI goes for 3rd rate hike this year

As it raised the rate for the third time this fiscal year – a total of 140 basis points in three months – the Reserve Bank of India (RBI) is set to increase the economy’s lending rates and EMIs to existing home loan customers.

Reserve Bank of India Governor Shaktikanta Das told reporters that the MPC has decided to continue to focus on withdrawing the easing to ensure that inflation remains within target in the future while supporting growth.

While he said there are indications at this time that “CPI inflation has peaked and is expected to decline in the fourth quarter of this year and the first quarter of next year,” providing the rationale behind the 50 basis point rise, Das emphasized, “Inflation remains uncomfortably high and unacceptably high and monetary policy must work. There are many uncertainties obscuring expectations and therefore monetary policy must work, and therefore, 50 basis points.”

In its statement, the Reserve Bank of India said that with inflation expected to remain above the upper bound in the second and third quarters, the MPC stressed that persistently high inflation could destabilize inflation expectations and hurt growth in the medium term.

“Consequently, the MPC considered that further calibration of monetary accommodation was warranted to keep inflation expectations steady and contain the effects of the second round. Accordingly, the MPC decided to increase the repo rate by 50 basis points to 5.4 percent.

Despite an increase of 50 basis points – the second such increase in two months and a total of 140 basis points in three months – stock markets remained strong and the Bahrain Bourse’s Sensex closed today at 58,387, an increase of 89 points.

While acknowledging that the Indian economy has been naturally affected by the global economic situation – globalized inflationary increases, tightening financial conditions, a sharp rise in the US dollar and declining growth across geographies – and has been grappling with the problem of high inflation, Das said India is expected to be among the fastest growing economies During 2022-23 (IMF forecast) due to its strong and resilient fundamentals.

The Reserve Bank of India maintained GDP growth of 7.2 per cent for FY23 and projected real GDP growth of 6.7 per cent for the first quarter of 2023 to 24.

“In an ocean of intense turmoil and uncertainty, the Indian economy is an island of macroeconomic and financial stability. Economic growth is resilient and this exists despite two black swan events and multiple shocks,” Das said.

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Global headwinds for growth

With the recent rise of 50 basis points, the Reserve Bank of India’s policy rate is now higher than the pre-pandemic level of 5.15 per cent in October 2019. Then the retail inflation rate was 4.62 per cent compared to 7 per cent in June. With further rate hikes not being ruled out, growth in India will also depend on the global economic outlook, which remains uncertain.

He said that the local economic activity is showing signs of expansion. If there is a slight increase on the urban demand front in the production of consumer durables, domestic air passenger traffic and sales of passenger cars, then indicators of demand in rural areas have shown mixed signals.

High-frequency indicators for the services sector such as rail freight traffic, port freight traffic, e-way billing, toll collection and commercial vehicle sales remained strong in June and July. Investment activity is also picking up…the manufacturing PMI rose to an 8-month high in July.

He also said capacity utilization in the manufacturing sector has exceeded its long-term average, “indicating the need for new investment activity in creating additional capacity.”

According to an RBI survey, capacity utilization in the manufacturing sector in the fourth quarter of 2021-22 rose to 75.3 percent versus its long-term average of 73.7 percent.

The Central Bank also expected inflation to reach 6.7 percent for the year 2022-2023. Anticipating its concerns about price increases, the Reserve Bank of India cited incidents of unseasonal and excessive rainfall, and increased transmission of input cost pressures to selling prices across the manufacturing and services sectors.

“Taking into account these factors, and assuming a natural monsoon in 2022 and an average price of crude oil (Indian basket) of US$105 per barrel, inflation is expected to be 6.7 percent in 2022-23,” Das said.

While consumer price inflation eased its rally in April, the Reserve Bank of India said it remained uncomfortably high and above the upper bound of the target.

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“Broad-based inflationary pressures and core inflation remains at elevated levels. Fluctuations in global financial markets affect domestic financial markets, including the currency market, leading to imported inflation,” the report said.

While the Reserve Bank of India forecast inflation of 7.1 percent for the second quarter, it expects it to drop to 6.4 percent in the third quarter; and 5.8 percent in the fourth quarter. It also expected the inflation rate in the first quarter of 2023 to reach 5 percent in the first quarter of 2023 to 24. The decline in inflation depends on the decline in global commodity prices and the decline in domestic edible oil prices on the background of improved supplies from the major producing countries. Resuming the supply of wheat from the Black Sea region, if it continues, could help bring down international prices.

Das also pointed to the growing trade deficit, which expanded to $100 billion in April and June 2022 at the expense of record imports of goods against the backdrop of rising global commodity prices.

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