RBI may extend rate hikes on worries over inflation-target breach

INDIA’S central bank may extend interest rate hikes amid worries that inflation would exceed its mandated target in the next 6 months, although a three-quarter point increase is unlikely in the June meeting, people familiar with the matter said. 

The Reserve Bank of India (RBI) opted for an out-of-cycle hike on Wednesday (May 4) as it did not want to shock the markets with super-sized increases in the June and August meetings, and to prevent inflation from overshooting the authority’s 2-6 per cent target range, according to the sources, who did not want to be identified. 

RBI governor Shaktikanta Das said the move to raise rates by 40 basis points and withdraw billions from the banking system may be seen as a reversal of the easing implemented in early 2020 to fight the impact of pandemic. That led to speculation in the market that the RBI may consider raising rates by 75 basis points in the June meeting, reversing what it had implemented back then.

RBI’s rate actions will be guided by the inflation trajectory and some market expectations of a 75-basis-point hike may be unfounded, according to the sources. The March headline number came as a surprise to the RBI and the April print could also show a spike, the sources said.

India’s retail inflation in March rose to a 17-month high of 6.95 per cent, a third straight month of remaining above the monetary policy committee’s mandate of 2-6 per cent. If inflation stays above the RBI’s 6 per cent tolerance limit for 3 straight quarters, the governor is required to write a letter to the government explaining the reasons for the surge in prices and the remedial measures.

Bonds sold off after the RBI’s shock rate increase, with the yield on 10-year bonds rising by 28 basis points in 2 days to Thursday.

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The RBI is extremely mindful that its hawkish measures will be negative for growth in the short term, but will stabilise it in the medium term, the sources said. 

The central bank is unlikely to implement bond purchases like it did last year via the government securities acquisition programme, even though it will support the record borrowing plan, they added. BLOOMBERG