RBI may extend rate hikes on worries over inflation target breach

By Anup Roy and Ronojoy Mazumdar

The Reserve Bank of India may extend interest-rate hikes amid worries inflation would exceed its mandated target in the next six months, although a steep three-quarter point increase at the June monetary policy meeting isn’t implied by its recent move, people familiar with the matter said.

The central bank opted for an out-of-cycle hike on Wednesday because it didn’t want to shock markets with super-sized increases in the June and August meetings, even as it steps up efforts to prevent inflation from overshooting the mandated 2-6% target range, according to people, who didn’t want to be identified.

RBI Governor Shaktikanta Das said the move to raise rates by 40 basis points and withdraw billions from the banking system may be seen as a reversal of the easing implemented in early 2020 to fight the impact of pandemic. That led to speculation in the market that the RBI would consider raising rates by 75 basis points in the June meeting, reversing what it had implemented back then.

Read | RBI is late to the inflation fight

RBI’s rate actions will be guided by the inflation trajectory and some market expectations of a 75-basis-point hike may be unfounded, according to the people. The March headline number came as a surprise to the RBI and the April print could also show a spike, the people said.

Credit: Bloomberg

“A one-step increase of 75 bps is highly unlikely,” said Gaurav Kapur, chief economist of IndusInd Bank Ltd. “You don’t want to give a shock the economy at this juncture when it is just about emerging from the pandemic. Besides, it goes against the guidance of a calibrated tightening.”

Das switched his focus to fighting inflation from supporting growth when he made a hawkish pivot in the April policy.

India’s retail inflation in March rose to a 17-month high of 6.95%, a third straight month of remaining above the monetary policy committee’s mandate of 2%-6%. If inflation stays above the RBI’s 6% tolerance limit for three straight quarters, the governor is required by law to write a letter to the government explaining the reasons for the surge in prices and the remedial measures.

Bonds sold off after the RBI’s shock rate increase, with the yield on 10-year bonds rising by more than 30 basis points in the past three days to Friday.

The RBI is extremely mindful that its hawkish measures will be negative for growth in the short term, but will stabilise it in the medium term, the people said.

The central bank is unlikely to implement bond purchases like it did last year via the government securities acquisition program, even though it will support the record borrowing plan, they said.

--With assistance from Anirban Nag.