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Can repo rate status quo help contain inflation?

The RBI kept its policy rate unchanged as expected at 6.5 per cent. Still, the major concern is in weather the step can help keep a tab on inflation. The upward revision in Q2 inflation forecast by 100 bps to 6.2 per cent and the decision to tighten liquidity through the incremental CRR for banks are ample indications.

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Can repo rate status quo help contain inflation?
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14 Aug 2023 12:34 PM IST

The RBI kept its policy rate unchanged as expected at 6.5 per cent. Still, the major concern is in weather the step can help keep a tab on inflation. The upward revision in Q2 inflation forecast by 100 bps to 6.2 per cent and the decision to tighten liquidity through the incremental CRR for banks are ample indications. The latter could reduce system liquidity balance by Rs 60-70k crore. The ICRR decision is to be reviewed next month and it could be a temporary decision as if inflation pressures continue to linger, then the possibility of continued durable liquidity tightening is likely. The RBI is set to bring inflation back to four per cent on a sustainable basis. HDFC Bank expects the inflation to average at 5.6 per cent in FY24 as it is expected to print above six per cent till September. Not to mention that inflation projections have been increased due to food prices. Excess liquidity due to Rs. 2000 notes, RBI dividend and capital flows might also fuel inflation. Hence, incremental deposits CRR have been increased by 10 per cent.

This will absorb excess liquidity, despite it being a temporary measure.

The message is clearly hawkish in response to the rising inflationary risks. This was reflected in both the significant upward revision in RBI’s inflation forecast and the decision to introduce 10 per cent incremental CRR for. On rates, HDFC Bank treasury research expects the RBI to remain on hold through FY24 and a rate cut is not likely before Q1. The RBI revised up its Q2 inflation forecast by 100 bps to 6.2 per cent, full year forecast to 5.4 per cent and gave a above per cent forecast for Q1.

While the central bank did recognise that vegetable price increases tend to be transitory and the recent rise could reverse sharply in the coming months, it also spoke about other inflation risks from cereals, pulses, and global commodity price increases. In addition, food inflation increases tend to have a greater influence on inflation expectations if sustained.

The RBI currently assumes a normal monsoon for August and September, but IMD has projected a below normal monsoon in August, which can present further upside risk to the RBI’s inflation forecasts going forward. In addition, food inflation increases tend to have a greater influence on inflation expectations if sustained.

Analysts expect inflation to average at 5.6 per cent in FY24, higher than the RBI’s forecast. Inflation for July is expected to print at 6.6 per cent. One can only hope that inflation continues to be under check. It should be more due to the conscious efforts being made by the apex bank. In case it happens, the country joining the club of the three most powerful global economies is inevitable.

policy rate RBI ICRR decision 
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