RBI is giving a very clear signal that inflation will see a long-term increase, say experts

The Reserve Bank of India (RBI) has decided to increase the Cash Reserve Ratio (CRR) by 50 basis points to 4.5 percent, Governor Shaktikanta Das said on Wednesday while making an unscheduled statement on monetary policy.

In an unscheduled 15 minute statement, the RBI governor changed the contours of financial markets — against no rate hike movement expected till June 7, he announced a 40 basis points (bps) increase in repo rate, a rate that has not been touched for several years now. What bites more is a 50 bps hike in the cash reserve ratio (CRR) to 4.5 percent.

The governor also went on to say that at the start of the pandemic, in one shot, the central bank had decreased the repo rate by 40 bps and now, it are going back to status quo with the 40 bps hike. In effect, Das is saying, "We are coming back to the pre-COVID situation," which means the governor’s idea of normalcy or at least pre-COVID normalcy is 5.15 percent, which means the RBI could be in a hurry to get there. It means from 4.4, another 70 bps hike should be expected, it could be three straight 25 bps hikes a 40 bps hike again in June and a 30-35 bps hike in the August policy.

RBI's move to hike CRR by 50 basis points to withdraw liquidity worth over Rs 83,000 crore

The all-round word is that the RBI’s credibility has been restored. This clearly establishes the RBI as a credible central bank because it has hiked before the Fed raise its rates and more importantly on a day when the giant LIC IPO is opening, which means there has been no fiscal pressure or sovereign pressure on the RBI.

Indranil Pan, Chief Economist, Yes Bank; DK Joshi, Senior Director and Chief Economist at CRISIL; Rupa Rege Nitsure, Group Chief Economist at L&T Financial Services; and Madan Sabnavis, Chief Economist at Bank of Baroda (BoB) shared their views.

“The RBI clearly indicates — or the governor’s statement indicates — that they are mindful of the growth implications of this policy and it will be calibrated in terms of how they want to take forward the removal of accommodation at this point in time,” said Pan.

“Our own growth forecast is at 7 percent but we had already indicated that there could be some downside risk and this is the point in time possibly when the downside risk could actually be manifesting,” he added.

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Joshi believes that the interest rate hike will reduce growth, ceteris paribus. “That is the only way the central bank can control inflation. It cannot control food inflation, it cannot control fuel inflation. It can only control its transmission to the rest of the economy and that it can do only by slowing the economy.”

Rupe Rege said today's move signals more hikes in the future. "They have given a very clear signal that they are seeing inflation rising on a durable basis. The central bank always goes by a forward-looking picture and we are seeing pressures from agricultural commodities as well as from the fuel side; trade deficit is widening and I think RBI’s move today is very timely,” said Rupa Rege Nitsure.

“Until March 31, I would tend to believe that there would definitely be an increase of around 50 bps in the repo rate and an upside of another 25 bps. So we could be looking at a terminal point of something like 5.15 percent,” said Sabnavis.