Rate hike that wasn’t, veggies push inflation
The RBI may have raised short-term rates without saying so. On Thursday, while keeping the benchmark repo rate unchanged at 6.5%, it announced an incremental Cash Reserve Ratio (CRR) of 10% on banks’ net demand and time liabilities (NDTL) between May 19 and July 28. The dates are significant. The former was when the RBI announced the withdrawal of Rs 2,000 notes, and the latter saw 87% of the pink notes returning to the system. All that stash is with banks, and the temporary CRR move will do two things: raise the amount of cash banks park with RBI, which it estimates at over Rs 1 lakh crore, and reduce system liquidity by a similar amount. But more than currency absorption, analysts expect short-term rates on money market instruments like call money rates, treasury bills, and commercial paper to increase by 15–20 bps.
The Rs 2,000 banknote removal spiked surplus liquidity to Rs 3.5 lakh crore. Yet, the weighted average call money rate, or the operating target of RBI’s monetary policy and one the central bank closely tracks, is in line with the repo rate. What, then, was the logic behind incremental CRR? It turns out that surplus liquidity puts pressure on interest rates, and Thursday’s decision preempted that from happening. Rising food prices, led by tomatoes, cereals, and pulses, have raised the inflation outlook for both July-August and FY24 to 5.4%. As seen in advanced economies, further price shocks may call back rate hikes. Moreover, risks such as uneven monsoons, looming El Nino conditions, and hardening global commodity prices also have a bearing on inflation.
While the Monetary Policy Committee (MPC) was willing to look through the perishable food price increases, recurring shocks could risk anchoring inflation expectations. As Governor Shaktikanta Das noted, the focus was reducing inflation to 4%, not merely getting it into the tolerance band. RBI remains watchful and is ready to act, which means, the October policy review may throw in one last rate hike if inflation continues to surge. Or, as Das said, RBI may ‘not resort to knee-jerk reactions’, and instead of repo rate, it may deploy any of the dozen-odd direct and indirect tools—like Thursday’s CRR—it has in its arsenal to douse inflationary fires.