In an unscheduled address, the Governor of the Reserve Bank of India (RBI) on Wednesday announced that the policy repurchase rate - the repo rate - and the cash reserve ratio were being hike by 40 basis points and 50 basis points respectively.
The steps are being taken to control runaway inflation that has persisted as a result of a mix of cues having a global domino effect, mainly the ongoing conflict in Ukraine and a post-COVID monetary policy normalisation.
The six-member Monetary Policy Committee, which usually meets every two months, met on May 2 and May 4 in an offcycle meeting to take the decision to unanimously hike the repo rate. Effective immediately, the repo rate will be 4.40%. This is the rate at which banks borrow from the RBI on a short-term basis.
Several banks offer popular credit products such as home loans linked to the policy repo rate. While a lower repo rate gave an impetus to credit during the pandemic, a hike in this rate will likely make fresh loans more expensive for new and existing borrowers alike, as banks tend to revise their repo-linked interest rates that they charge borrowers frequently.
The cash reserve ratio is the percentage of time and demand deposits that banks have to keep with the RBI. This was lowered to 3% right after the first COVID-19 lockdown in March 2020 in the first surprise announcement by Das during the pandemic, but was restored to 4% by May 2021.
Now, it is being further hiked to 4.5%, effective from the fortnight starting May 21. This is expected to take nearly ₹87,000 crores out of the monetary system.
Interest rate hikes act as a counter to rising inflation - that's the general cost of goods and services - as it is as a quantitative tool to subdue demand, by way of lesser money (due to more expensive lending and more incentivised saving) chasing the same amount of goods and services in the economy.
To provide context, consumer inflation rose to 7% in March 2022 from 6.1% in Februrary. Food inflation rose 154 basis points to 7.5%, and is expected to remain under pressure according to Das. Further, global uncertainties remain due to no sign of easing in the ongoing conflict, and a resurgence of COVID-19 infections globally, especially in China, which remains a crucial supply link in the global economy.
Markets have not reacted favourably to this announcement. The benchmark NIFTY of the National Stock Exchange is down 2.33% or nearly 400 points at 16,671 points and Sensex of the Bombay Stock Exchange is down 2.4% or 1,366 points at 55,609.
Read Das' announcements here.