India central bank raises key rate by 25bps to 5.5%
The Indian central bank raised its benchmark repo rate by 25 basis points to 5.5% on Wednesday, marking the first rise in nearly four years amid mounting inflation and strong economic growth.
The central bank also signalled further rate hikes by changing its stance from “neutral” to “calibrated tightening”, but Governor Sanjay Malhotra said the extent and timing of any more increases would be contingent on actual inflation and growth outcomes.
India has joined major central banks in raising rates as higher oil prices triggered by the Iran war fuel inflation, squeeze purchasing power and weigh on currencies.
Weak monsoon rains linked to El Niño have compounded price pressures in Asia’s third-largest economy.
The six-member rate panel voted unanimously in favour of the rate hike.
Nearly 60% of economists in a Reuters poll had expected a 25 bps increase in the repo rate.
“The Indian economy has been strong, and economic momentum remains broad-based,” Malhotra said, adding that the inflation outlook had worsened since the last policy meeting.
There is some evidence of elevated inflation expectations and broadening of price pressures, Malhotra said.
“It is clear that inflation and its outlook are not benign as they were last year.”
The RBI now expects inflation at 5.2%, a small increase over its earlier forecast of 5%. Core inflation is seen at 4.4% from 4.3% earlier.
Analysts have been divided on how far the central bank will go in raising rates.
“We expect another 50-75 basis points in rate hikes over the coming months,” said Sakshi Gupta, economist at HDFC Bank.
“In the event that the West Asia conflict lingers and oil prices remain elevated, the inflation risk could increase further, necessitating a more aggressive tightening cycle,” Gupta said.
India’s benchmark 10-year bond yield was slightly higher at 7.2269%, while the rupee currency hovered around its previous close at 96.43 against the US dollar.
The benchmark Nifty 50 Index was down 0.3% but recovered from the day’s lows.
Higher inflation
Consumer inflation accelerated in August to 4.82% from a year earlier, above the Reserve Bank of India’s 4% medium-term target for a third consecutive month.
Higher prices of fuel and food are now rippling through the economy, with nearly half of the consumer basket seeing inflation above 4%.
“Headline CPI inflation is expected to average almost 5.8% in the next three quarters,” Malhotra said.
“In this milieu, recalibrating the policy rate is imperative”.
At the same time, economic growth remains strong, giving the central bank greater leeway to raise the cost of borrowing for consumers and businesses.
The central bank expects GDP growth in the current financial year at 7.1%, 40 bps higher than its earlier projections.
GDP growth for the April-June quarter stood at 7.8%, well above the central bank’s forecast of 7%.
Malhotra said there is limited evidence of demand-side pressures in inflation so far, but risks exist “in view of strong growth in monetary and credit aggregates.”
India’s bank credit growth has soared in the past few months and grew by 18.8% in October, reflecting strong demand.
Managing liquidity
Contrary to market expectations, the central bank refrained from announcing additional measures such as a hike in the reserve ratio to drain surplus liquidity from the banking system.
“The Reserve Bank will use an appropriate mix of liquidity management tools,” Malhotra said.
Schemes to draw dollars and support the rupee drew close to $144 billion as of mid-September, according to central bank data.
These dollars, swapped with the central bank, led to a flood of liquidity which peaked at a record 11.16 trillion rupees at the beginning of September.