Hike rates

Rbi could raise rates by 75 basis points by August amid war-induced high inflation, Sbi economists say

The Reserve Bank of India (RBI) is expected to raise rates by another 0.75% to bring the repo rate back to the pre-pandemic level of 5.15%, SBI economists said on Monday.

The report, authored by Dr. Soumya Kanti Ghosh, the group’s chief economic adviser, SBI, attributes about 59% of the acceleration in inflation to the impact of the geopolitical conflict sparked by the war in Ukraine.

Report Highlights:

– Inflation continues to be a pet peeve and it seems unlikely that it will correct itself anytime soon. The latest inflation figures reveal, however, that while in rural areas the impact has been disproportionately higher for food prices, in urban areas it is disproportionately higher for the impact and pass-through of fuel prices since the beginning of the war.

– We did a gauge study to understand the exclusive impact of war on the inflation trajectory in rural and urban areas. Using February as a baseline scenario (the start of the Ukraine-Russia conflict), our study finds that due to the war alone, food and beverages (assuming the increase in vegetable prices was mainly due to seasonal factors, which are largely domestic) and Fuel and Light & Transport have contributed 52% to the increase in headline inflation since February. If we also add the impact of input costs, especially on the FMCG sector, thus adding the contribution of personal care and effects, the total India-wide impact amounts to 59%, only because of the war.

– Faced with the continued rise in inflation, it is now almost certain that the RBI will hike rates in the upcoming June and August policy and bring it back to the pre-pandemic level of 5.15% by August . However, the significant challenge facing the central bank remains whether inflation will significantly slow due to such rate hikes if the war-related disruptions do not ease soon.

– In particular, as retail loans are indexed to an external rate (mainly to the RBI repo rate) with a quarterly reset clause, the interest rate on loans indexed to the repo rate will increase directly with the repo rate increase. As of December 2021, approximately 39.2% of loans are indexed to external benchmarks, so increasing the repo rate will eventually increase interest charges. In a situation of a nascent post-Covid demand recovery, the question will be whether growth could be a big casualty in the event of large and persistent rate hikes, even if inflation footprints will continue to be a serious concern.

– It should be noted that the transmission to lending rates since October 2019 reveals that even though the repo rate has been reduced by 140 basis points, the weighted average lending rate (WALR) on new rupee lending has decreased by more than 186 basis points. This was one of the main reasons for the significant increase in credit impulses during the pandemic, apart from the financial stability issues addressed eloquently by RBI using the yield curve as a public good. The current turmoil somehow mirrors such a conundrum the RBI has faced while navigating through the pandemic, as bigger rate hikes to stifle inflation could impact nascent growth impulses. Additionally, the RBI may need to use a shorter window to address inflationary concerns given the challenges of realpolitik in the not-too-distant horizon.

– We must therefore support RBI in its efforts to curb inflation through interest rate hikes. A higher interest rate will also be positive for the financial system as risks will be reassessed. The situation is different from that of the global financial crisis, where lending began to increase aggressively from March 2009, well before the start of the rate hike cycle (from March 2010 to March 2012). Currently, the rate hike cycle has begun and now bank lending will increase based on the proper pricing of risk and demand. Interestingly, personal personal loans grew at a blistering 23.1% in FY22, with an interest rate well above home loan rates, which are EBLR-linked rates. . Additionally, household debt as a % of GDP has now fallen to 31.8% of GDP in March 2022 from a high of 37.2% in March 2021.

– There is, however, a point of caution. The internals of Indian inflation are very different from those of advanced economies such as the United States. Growing wage pressures, reflected in decades-long strong annual wage growth, are fueling widespread price pressures across advanced economies. In contrast, in India, nominal rural wages for agricultural and non-agricultural workers increased in H2 FY22 as state restrictions/lockdowns eased and economic activity restored. However, wage growth remained weak. The weighted contribution of wage growth to the construction of the CPI remains modest. So even after rate hikes, inflation will take time to moderate in India.

– We also strongly recommend that the RBI can intervene in the NDF market instead of the onshore market through banks during the Indian time zone, as this has the advantage of not affecting rupee liquidity. This will also save foreign exchange reserves, with only the settlement of the differential amount with counterparties at maturity.

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