RBI likely to raise key policy rate by 25-35 bps to check inflation: Experts

Experts believe that the RBI may hike policy rates by 25-35 basis points for the third time in a row to combat high retail inflation, just days after the US Fed raised interest rates. The Fed has already stated that it will gradually withdraw its accommodative monetary policy stance.

The Reserve Bank’s rate-setting panel, the Monetary Policy Committee, will meet on August 3 for three days to discuss the current economic situation before releasing its bi-monthly review on Friday. The RBI raised the short-term borrowing rate (repo) twice in six months, by 40 basis points in May and 50 basis points in June, as retail inflation remained above 6%.

The current repo rate of 4.9 percent remains lower than the pre-Covid level of 5.15 percent. To deal with the crisis caused by the pandemic outbreak, the central bank sharply reduced the benchmark rate in 2020. Experts believe the Reserve Bank of India (RBI) will raise the benchmark rate to at least the pre-pandemic level this week, and possibly even higher in the coming months.

“We now expect the RBI MPC to raise the policy repo rate by 35 basis points on August 5 and shift to a calibrated tightening stance,” according to a report from BofA Global Research. It also stated that an aggressive 50-bps hike and a measured 25-bps hike cannot be ruled out.

According to a Bank of Baroda research report, while the Federal Reserve raised rates by 225 basis points in CY22, the RBI raised the repo rate by 90 basis points. The Fed’s aggressive rate hike is fueling speculation that the RBI will also front load its rate hikes. However, the RBI added that the current situation in India does not warrant an aggressive stance.

“…in the absence of new shocks, India’s inflation trajectory is likely to follow the RBI’s projections.” As a result, we expect the RBI to raise rates by only 25 basis points in August’22, followed by another 25-basis point hike in the next two meetings,” it said.

The government has directed the Reserve Bank to keep consumer price index-based inflation at 4%, with a 2% margin of error on either side. While other banking regulators around the world, including the US Federal Reserve, are raising rates aggressively, the situation in India, according to Dhruv Agarwala, Group CEO of Housing.com, does not warrant that kind of approach just yet.

“Our estimate is that it will be in the range of 20-25 basis points,” he said.

Radhika Rao, Executive Director and Senior Economist at DBS Group Research, stated in a report that the RBI monetary policy committee will remain focused on price stability over the next two quarters.

With peak inflation expected in the July-September quarter, “we now expect a 35 basis point hike in August, followed by three 25 basis point hikes for the terminal rate to level off at 6% by end-FY23,” she predicted.

Since January 2022, retail inflation based on the Consumer Price Index (CPI), which the RBI considers when determining monetary policy, has exceeded 6%. In June, it was 7.01 percent.