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The Monetary Policy Committee (MPC) increased the policy repo rate by 40 basis points to 4.40 per cent off-cycle to avoid taking a ‘cold turkey’ approach to raising interest rates down the line, according to sources aware of central bank’s line of thinking.
Cold turkey approach means sudden upward shift in policy rates.
Referring to the March 2022 retail inflation print of 6.95 per cent, which came on April 12 after the RBI’s April 8 policy announcement, the sources said this reading was a surprise for most people, including professional forecasters, because the RBI had projected it at a little less than 6.50 per cent.
Since then, data seems to suggest that prices are rising more than what the RBI anticipated, and that would add momentum to the next inflation print.
The average inflation rate in the January-February-March (JFM) quarter of 6.34 per cent became the first quarter of failure to rein-in inflation below the 6 per cent upper tolerance band.
Inflation target
As per the statutory and institutionalised framework for the MPC, if the average inflation is more than the upper tolerance level of 6 per cent or less than the lower tolerance level of 2 per cent for any three consecutive quarters, it would mean a failure to achieve the inflation target.
Given the developments in April after the policy announcement, it looked imminent that the April inflation number would be an equal shocker, raising doubts in policy makers minds that they were going to face difficulties in the second consecutive quarter, sources said.
“Hence, it was important to get enough time to space out policy actions and not do a cold turkey….Now, imagine if a 115 basis points hike had to be spread over June and August, what a shock that would be?” said the sources.
Finally, the Committee just reversed the May 22, 2020, repo rate cut of 40 basis points. On March 27, 2020, the MPC slashed the repo rate by 75 basis points in the face of the Covid-19 pandemic to support the economy.
“Each action of the RBI is mutually independent of the other….If the tide changes (war ceases), the central bank may not want to hike rates any more and it will step back into accommodation because the economy needs to be supported at this point of time. But the war has brought exigency on the entire world,” sources said.
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