India: RBI unexpectedly rose the interest rate to 4.40% - UOB

Economist at UOB Group Barnabas Gan comments on the recent decision by the RBI to raise the interest rate.

Key Takeaways

“The Reserve Bank of India (RBI) raised interest rates in an unscheduled policy move yesterday (4 May 2022). The decision to raise the benchmark repo rate by 40bps to 4.40% was voted by all six members. This is the first repo rate hike since Aug 2018, after keeping it unchanged for 11 straight policy meetings prior.”

“Effective 21 May 2022, the cash reserve ratio will also be raised by 50bps to 4.5% of net demand and time liabilities. This is estimated to absorb a total of INR870bn of liquidity from the banking system.”

“The decision to raise interest rates was likely in view of higher inflationary pressures for the year ahead. Notably, inflation was 6.95% y/y in Mar 2022, and significantly above the central bank’s upper tolerance threshold of 6.0%.”

“Moreover, policy-makers cited further downside risks following the geopolitical tensions and sanctions against Russia. Notwithstanding the risks, we note that high-frequency data since the start of this year had been supportive of India’s economic growth.”

“As cited in our previous RBI report, the decision to adopt a hawkish stance and a higher liquidity adjustment rate in Apr 2022 is a decisive signal for RBI to gradually exit its accommodative monetary policy stance. RBI’s decision to hike rates in May, while being earlier than we had thought, is in line with our call for higher policy rates into the year ahead. As such, we expect further 25bps rate hike each in 3Q22 and 4Q22, to bring the repo rate to 4.90% by year-end.”