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As expected widely, the regulator brought in the sledgehammer, hiking the policy repo rate by 50 basis points to rein in stubbornly upward inflationary pressures. More so in the wake of a new ‘globalized inflation’ concept, which is likely to affect future inflation projections, while altering notions woven around uneven growth patterns. As inflationary expectations are likely to hover much above the mandated tolerance level, and the global effects of the war in Europe proliferate on many fronts, from rapid migratory patterns and enhanced spending on vitals like food and energy to scrambles for procuring critical raw materials in time at elevated costs and scarcities of fertilizer inputs, the likelihood has risen of the Reserve Bank of India (RBI) continuing its drive to align policy rates with these stark realities, front loading its moves while staying vigilant on economic growth.

The central bank’s monetary policy statement on Wednesday, headlined by a unanimous vote for a decisive rate increase, is also a smart message for markets: of an authority that speaks in unison. This helps negate any market cacophony of interpreting divergent views at a time when global uncertainty has peaked. Markets have welcomed the policy, with yields declining after its announcement. Significantly, RBI also upped its inflation projections for 2022-23 to 6.7% from 5.7%, along with its forecast for crude oil prices, now projected to average $105 per barrel, though it can surprise on the upside. The inflation projection has been set higher than the market consensus. This clearly indicates that RBI acknowledges it as a clear and present danger.

The good thing is that even as global uncertainties are in abundance, growth numbers continue to inspire optimism. Capacity utilization rates have now moved up to 74.5%, with new investment announcements at a record high of 20 trillion in 2021-22 and India’s manufacturing sector leading from the front. This will give comfort to RBI in pushing through rate hikes and maintaining inflation control as its foremost objective, as was evident in the policy statement. However, the governor has also alluded to the proactive role that fiscal policy can play in unison with monetary policy. This could involve states cutting their value added tax on fuel. Interestingly, economic literature suggests that monetary contraction accompanied with fiscal expansion is often ideal for policy coordination to deliver the maximum payoff.

In recent times, there has been much misunderstanding over the introduction of RBI’s standing deposit facility (SDF) at 3.75% in April, a move that served as a rate hike, as the governor recently emphasized. Ideally, an SDF operates with no collateral of G-Secs given by RBI to banks for the deposits they make, unlike how the reverse repo system works. However, this policy was changed by letting deposits under SDF be counted as a part of a bank’s statutory liquidity ratio (SLR) requirement, thus effectively pushing up the short-term rate to 3.75% and making the reverse repo rate redundant. The SDF rate is currently at 4.65% and the variable rate reverse repo (VRRR) was at 4.39% before Wednesday’s policy. Over time, the SDF (currently for overnight funds) and VRRR (in multiples of fortnightly durations) are likely to find a dynamic meeting ground. Note that RBI has been anchoring VRRR all through this turbulence, giving banks better yields on floating deposits while signalling normalization through alignment with market-determined rates.

RBI’s forward guidance has also been suitably crafted and made crisper in the policy statement; “accommodative" was dropped from its stance, while “withdrawal of liquidity" was indicated as the preferred option in combating inflation. Throughout the pandemic, RBI has been largely successful in communicating its intentions to the market. The RBI governor had firmly conveyed the steadfast resolve of monetary policy during the pandemic through a crisp one liner. This communication has remarkable convergence with recent research, which states that central bank communication should be simple and constructively imprecise. “Whatever it takes" met that criterion very well.

Additionally, pragmatic measures for cooperative banks should create a level-playing field, while also giving a fillip to the housing sector and delivery of services at doorsteps. RBI’s efforts to align regulations with global practices in promulgating margin requirements for non-centrally cleared derivative contracts should promote the twin objectives of systemic risk reduction and nudging participants to embrace central clearing.

The large number of touch points deployed should further augment our payment infrastructure in targeted geographies. Linking RuPay credit cards with the unified payments interface (UPI) will help universalize UPI-based services and benefit some 15 million RuPay card holders who can use it at 180 million UPI QR-code platforms.

We believe that RBI is likely to take the repo rate beyond its pre-pandemic level by August, and 5.5% looks likely in October. Beyond that, rate hikes could come incrementally in case the inflation trajectory shows an upside surprise.

These are the author’s personal views.

Soumya Kanti Ghosh is group chief economic advisor, State Bank of India

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