SBI Research issued a recommendation to the Reserve Bank of India (RBI) regarding the need for a more aggressive approach to setting the repo rate. The researchers suggested considering a 50 basis point increase in the rate by December, citing rising global inflation, ongoing financial turmoil, increasing capital costs, and currency volatility.
At the Ecowrap event on October 9, SBI Research emphasized that the current situation requires a strategic shift that should include a significant interest rate hike, as well as stabilization of liquidity and foreign exchange markets. Furthermore, the report discussed the possibility of taking policy measures outside the standard procedures of the RBI while awaiting decisions on monetary policy.
SBI Research forecasts that economic growth rates will remain resilient, potentially exceeding 7.5 percent. In their view, an interest rate hike could be justified at the December policy meeting. It is important to note that these proposals are presented to the RBI only as recommendations.
The report points to increased global uncertainty, fluctuations in government bond interest rates, concerns over commodity shortages, and changing expectations regarding US interest rates. These events have heightened instability in financial markets and put pressure on emerging market currencies. SBI Research argues that emerging economies may suffer losses due to increased volatility in global capital flows and deteriorating access to and cost of funds.
The report also cautions that recent interest rate changes made by the RBI have had a limited impact on bond yields and exchange rates because markets have already priced in this change. Consequently, the timing and scale of the next policy response are of particular importance.
In addition to raising the interest rate, SBI Research proposed increasing the Liquidity Adjustment Facility (LAF) corridor by 50 basis points and maintaining it at a high level for a limited period. With the current repo rate at 5.5 percent, the report indicates that the RBI can adjust marginal lending and reverse repo rates within liquidity management, irrespective of MPC decisions on the target rate. This aligns with the central bank's actions during the 'taper tantrum' of 2013 and the COVID-19 crisis in 2020, which served as examples of corridor expansion during periods of financial stress.
A more substantial interest rate increase could help strengthen confidence in monetary policy and control inflationary risks. However, it would also lead to higher borrowing costs for both individuals and businesses. High interest rates may put pressure on investment and credit demand, and tight financial conditions could affect economic activity.
SBI Research also called for the implementation of government measures to strengthen foreign exchange management and attract long-term capital into credit and equity markets. In conclusion, the report asserts that the RBI must strike a balance between growth and financial stability to cope with continuous shocks.