Why RBI should hit pause on repo rate hikes till June

The Reserve Bank of India (RBI) Governor, Shaktikanta Das, and his Monetary Policy Committee (MPC) members would be in a Hamlet-like to-raise-the-repo-rate-or-not dilemma on April 6 when they announce their decision on policy rates.

The MPC has two critical tasks to weigh before taking a decision on changing the stance regarding ‘repo rate hike’ from accommodation to neutral.

Globally, developed countries are witnessing high inflation coupled with low growth/output. To arrest the recessionary trends, the US Federal Reserve, the European Central Bank, Bank of England and the Swiss National Bank have continuously raised their interest rates during the last year, and the said banks have hiked the interest rates by 0.25%, 0.5%, 0.25% and 0.5%, respectively, during the last month.

Hence, the RBI is in a compelling position to raise the repo rate to protect the rupee from depreciation. The rupee has depreciated by (-)8% during 2022-23.

Our domestic inflation — both CPI & core (minus food and fuel) — is above the RBI/MPC mandated tolerance limit of 6%. During January 2023, CPI was at 6.52% and in February at 6.44%; inflation has been stubborn. Core CPI has also been sticky right from November 2022 onwards till February 2023 and is above 6%. Cereals and product inflation has skyrocketed to 16.73%, ‘milk and milk products’ inflation is at a staggering 9.65% and housing inflation is at 4.83% (4.62% in January 2023). Hence, the RBI might continue with the rate hike spree by another 25 bps (cumulatively the increase in repo rate has been 250 bps from May 2022).

Though most economists, analysts, surveys and the ‘money market’ have factored in a 25-bps repo rate hike, it is desirable and prudent for the RBI to ‘pause’ the rate-hike cycle, at least till the June review, for the following reasons:

1. The core sector performance sequentially as at February is down by 7.8%; the first decline in five months and at a three-month low of 6% in February from 8.9% in January. Crude oil is in the negative zone (-) 4.9 %. This index has ‘40% weight’ in the Index of Industrial Production (IIP), which will also dip in February to around 4.2% (it was 5.2% in January).

2. El Niño effect/unseasonal rains in March can further dent the agricultural output.

3. A repo rate hike of 25 bps, if done, will force banks, HFCs and NBFCs to raise their onward lending rates on all the retail loans — housing, personal, vehicle loans — and also on loans to corporates, MSMEs, real estate, which are engines of growth. This will not only dent growth via the multiplier effect but will also impact private CAPEX.

The increase in lending rates has already affected the demand for affordable housing, which has dwindled by 26% in 2022 from 39% in 2018. Even the supply of affordable housing has been affected and has reduced 20% out of 3,57,650 units in 2022 compared to 26% of 2,36,700 units in 2021. This will further extend the timeline of achieving ‘housing for all’ by March 2024.

Moreover, the ‘rate hike’ will always work on the ‘lag’ effect. Even with the cumulative increase in repo rates by 250 bps, banks have only increased the lending rates by 125-150 bps and deposit rates hardly by 100 bps. So, even without the contemplated hike of 25 bps in April, the banks will raise interest rates from April onwards to bridge the ‘lag gap’.

4. Prices of Brent crude have fallen from $90/bl to less than $79.93/bl, which will soften not only the CPI inflation but also the cereals and food inflation. It will backstop the cascading effect of price rise on other essential commodities and transport inflation.

5. The methodology of calculation of CPI is itself questionable and doesn’t reflect reality. The base year for CPI calculation — ‘2012 basket of goods and services’ — has unrealistic ‘weights’ assigned to food/food constituents, as the whole ‘consumer preferences and choices’ have transformed significantly over past 10-15 years with changes in demographics, millennials/Gen Z on the rise, embrace of digitalisation in buying and payment preferences/eating habits.

Thus, it warrants a thorough overhaul with a new base year of 2020 at least with a revision of the current assigned ‘weight’ of 47% in the CPI, which is very high.

6. Even the math adopted in January and February CPI calculation is questionable.

The CPI assigning ‘zero weight’ to free rice and wheat provided under the PMGKY and re-distributing the ‘weights’ to other items under ‘cereals’ leads not only to serious discrepancies but also distorts the ‘inflation’ position of certain categories, which may not be experiencing high inflation.

Taking policy decisions with incongruent, inconsistent benchmarks/unrealistic ‘weights’ will lead to untold miseries to all stakeholders by way of undue hike in bank interest rates, loan tenure increases even after retirement age, banks developing cold feet towards aggressively lending to growth sectors and ‘bond values’ held by banks getting severely devalued on account of unjustified ‘rate hikes’.

Keeping in view the above factors, it is prudent for the RBI to ‘pause’ on the rate-hike cycle and adopt a wait-and-watch approach till the next review in June 2023.

(The author is a former banker)