India Stuns Market With Surprise Rate Hike In Unscheduled Meeting Ahead Of Fed
In a preview of what an overly hawkish FOMC statement today could do to markets, overnight India’s central bank hiked its key policy rate in a surprise move, the first hike since June 2018, leading to a broad-based selloff in bonds as the fight against inflation becomes real, with the Federal Reserve also expected to hike rates by 50 bps when it meets later today.
The Reserve Bank of India unexpectedly raised the policy repo rate - its main lending rate - by 40 bps to 4.40% highlighting continuing inflation risks amidst a broad-based growth recovery even as it decided to "remain accommodative while focusing on withdrawal of accommodation".
In order to tighten banking system liquidity, the RBI decided to increase the cash reserve ratio (CRR) by 50bp to 4.5% of aggregate deposits. The withdrawal of liquidity through this increase in the CRR would be of the order of INR 0.9tn per the RBI, and is expected to move the weighted average call money rate – the operating target of monetary policy, which was dipping below the bottom of the policy rate corridor (i.e. below the standing deposit facility, or SDF) – higher. This would aid in the transmission of policy rate hikes in the economy.
In the most recent policy meeting on April 8, the RBI made a hawkish pivot by:
- a) recognizing inflation risks by raising inflation forecasts by 120bp from the February policy meeting,
- b) setting inflation control as a priority over growth,
- c) reinstating the policy corridor to pre-pandemic levels by introducing a new deposit facility at 3.75% (40bp above the existing reverse repo rate), and
- d) changing the language of the policy stance to remaining accommodative "while focusing on withdrawal of accommodation".
In the inflation data that was released on April 12, the headline CPI print for March came in at 7% (60bp above consensus expectations) driven by an upside surprise in food prices (Exhibit 1). Food inflation increased to 7.5% yoy, highest since November 2020, driven by broad-based increase in food prices. (Exhibit 2). Core inflation increased to 6.3% yoy which was driven by an increase in core goods inflation to 7.5% yoy (7.1% yoy in February) while core services inflation almost remained flat at 4.8% yoy (4.7% yoy in February)
It is not clear what prompted the RBI to start the policy rate hiking cycle in an off-cycle meeting, given that the Governor had earlier stated that the RBI's actions would be "calibrated and well-telegraphed", and the next scheduled policy meeting is just over a month away (June 6-8). It is possible that the higher than expected inflation print in March 2022, and policy rate hikes by other central banks, including the US Fed prompted a sharp pivot in the RBI's monetary policy reaction function.
While the RBI did not give updated inflation or growth forecasts with today's policy statement, most banks continue to forecast inflation to remain higher for longer, and materially above the RBI's last published forecast for 2H 2022. In its post-mortem note, Goldman writes that today's off-cycle hike suggests the RBI will now implement a faster and more decisive monetary policy tightening cycle, and now forecasts the RBI to hike the policy repo rate by 50bp further in the June 2022 meeting, followed by 25bp hikes each in August, October and December meetings: "We thus forecast cumulative further 125bp repo rate hikes in 2022, with an additional 100bp repo rate hikes in 2023. On a cumulative basis, we now forecast 265bp of rate hikes in this cycle from 200bp earlier."
Following the shock hike, the Indian 10-year yield rose to a three-year high and is now testing resistance from a long-term trendline originating from the 2013 taper tantrum surge. Any break and close above this resistance of 7.33% for the month will bring 7.94% into focus, with tactical resistances coming into play in the 7.50% - 7.70% area, according to BBG's Akshay Chinchalkar.
Commenting on the surprise hike, Deepak Jasani, head of retail research at Mumbai-based HDFC Securities said that India’s interest rate-sensitive sectors like automobiles and housing will be hit particularly hard by the surprise rate hike by the central bank. He said that while the RBI’s rate increase was expected, timing was a surprise, with stocks already in weak territory due to inflation, war in Ukraine.
S&P BSE Consumer Durable Index -3.8% at a two-month low; S&P BSE Realty Index -3.4%, while S&P BSE Auto Index down 2.5%; benchmark S&P BSE Sensex and gauge of bank stocks down 2.3%
That said, even in India, investors await U.S. Fed’s guidance on further tightening later in day for next session; a less hawkish outlook on rate increases could support a relief rally in stocks.