rbi: RBI Governor Shaktikanta Das joins the chorus for tightening rates

Reserve Bank of India Governor Shaktikanta Das did what the market wanted him to do – keep rates and monetary stance unchanged. But he said something it didn’t want to hear – that the punch bowl is being taken away.

After being a crusader for economic growth during his entire first term and the first few months of the second despite an inflation targeting mandate, Governor Das has taken a U-turn as price pressures threaten to get out of hand due to war that adds fuel to already soaring prices.

“In our sequence of priorities, we have now put inflation before growth,” Das said to the shock of bond investors who were expecting the tightening message to be telegraphed in a milder manner. Das had never been more assertive on tackling inflation.

Stars are now aligned for the beginning of tightening interest rate cycle as inflation is here to stay – whatever the reasons are. Be it supply shocks, or demand pull due to excessive money supply, the monetary policy has just one tool to contain it – interest rate.

Yields on the benchmark bonds surged 21 bps to 7.12%, near a three-year high. Swap yields are up 30 to 40 basis points. One-year swap rates are signalling overnight rates at 5.5% by the end of the year.

It appears the market has been woken up from slumber. Persistent policy priority of reviving growth over inflation and the compulsion for RBI to ensure a smooth government borrowing had lulled investors into complacency. “While the fallout of the geopolitical situation is being assessed and will be factored into our projections, it is reasonable to treat it as a supply shock at this stage in the setting of monetary policy,” deputy governor Michael Patra had said in March.

With Friday’s commentary by the Governor, there’s no doubt that the economy has entered the tightening cycle. But the question is, when is the first rate increase likely, and for how long would that continue? It may be easier to answer the first than the second.

The first increase may well come in as early as June. There is a possibility that inflation may breach the 6% upper tolerance band for three consecutive quarters that may force the MPC to explain why it failed to meet the target. Having telegraphed the forthcoming shift in stance, a couple of increases could well be the Monetary Policy Committee‘s defence against a possible breach of the target.

Furthermore, financial stability could also come into play. Dr Patra admitted that real interest rate has to move to positive, which means a substantial increase if price pressures persist.

But the MPC under this Governor hasn’t played by the textbook. It’s unlikely to be a mechanical 25 basis points increase meeting after meeting. Although tightening liquidity and interest rate increases have been telegraphed, the RBI has given itself enough room to manoeuvre.

Oftentimes, it is the liquidity which determines the market interest rates rather than the actual interest rates of the monetary authorities. When it came to tightening liquidity, Das said it could be a “in a multi-year timeframe, it can be 2 or 3 years and will depend on the evolving situation.”

Das may well have bought an insurance policy as he jumped on the tightening bandwagon, which some thought he had missed.