India’s hawkish pivot lifting repo rate to three-year high

Bloomberg

India’s central bank would have to gradually hike the benchmark interest rate to its highest in three years as it battles to curb inflation that’s hovering above its targeted range, economists said.
The Reserve Bank of India (RBI) might change its stance to neutral from accommodative in the June policy, topping it up with a 25 basis points rate hike, they say. That will be the start of a tightening cycle that could eventually see the repo rate end at around 5.5%-5.75%, predict economists from Deutsche Bank AG to Citigroup Inc.
That level was last seen in June 2019, when Governor Shaktikanta Das switched to an accommodative bias from a neutral policy stance and subsequently slashed rates to record lows of 4% to support an economy hit hard by the pandemic.
Last week, though, Das signalled a shift in policy focus as he joined other global central banks in ramping up efforts toward withdrawing accommodation to check inflation. The RBI also moved to soak up excess liquidity in the banking system, steps that economists said opened the gate for a tightening cycle that will see the terminal repo rate at 5.5% over the next two years, according to the
median in a Bloomberg poll.
“We expect another 100 basis points of cumulative rate hikes in 2023, which should push up the repo rate to 5.75% by end-December,” Das added.
Predicting the terminal rate, or the peak rate, has sprung up as the next big bet among traders in emerging markets. While Latin American nations have emerged as the front-runner in this high-stakes guessing game after nations there began aggressive tightening about a year ago, central banks in Asia have barely budged.
Yet, with the Federal Reserve set to raise rates faster and inflation and supply chain problems due to the war in Ukraine making inflation more entrenched, policy makers will be left will little choice but to react.
India’s headline inflation raced to a 17-month high of 6.95% in March from a year earlier, the government said. That was above the RBI’s targeted range of 2%-6%, with inflation averaging above 6% for the January to March period.
If readings remain above 6% for the next two quarters, a scenario Citigroup economists see as likely, the central bank under law will have to explain why it missed the target, and suggest steps to bring prices under control within an estimated period.
To be fair, the flexible inflation targeting regime which the RBI adopted in 2016 has broadly helped in cooling price pressures. That is one of the reasons why India’s terminal repo rate in this tightening cycle could be lower than the previous ones. In the previous tightening mode seen in 2018, the repo rate ended at 6.5%, with inflation hovering a shade below 5%.
Before that, in the rate hike cycle seen in 2013 to 2014, the repo rate ended at 8%, with inflation as high as 11.5%.
The specter of double-digit inflation seems unlikely, though, despite prices of crude, India’s biggest import item, hovering above $100 a barrel. The RBI is projecting average inflation in the April to June period at 6.3%, at 5.8% in the quarter after that and 5.4%
between October to December.
Economists say there are upside risks to that projection, especially after the latest inflation report.
“The March print strengthens rate hike expectations in June,” said Madhavi Arora, lead economist at Emkay Global Financial Services Pvt Ltd. “We maintain that FY23 could see a rate hike of upto 100 basis points. The terminal rate may go a tad higher from 5.25%.”