Instead of reacting to every rate hike, continue your investments according to your financial goals.
Today we all know that the Reserve Bank of India (RBI) is increasing interest rates. It has delivered the first instalment on May 4, 2022, by increasing the signal repo rate—the rate at which the RBI lends to banks — by 40 basis points (0.4%) from 4% to 4.4%. We know that there is more to come. Let’s take a perspective on the way forward, for clarity.
The primary objective of the RBI is to control inflation, while keeping in mind the objective of growth. Inflation is a concern now, which necessitates that the RBI increase interest rates. Though growth will be impacted to an extent due to higher interest rates, the RBI does not have a choice now. Rather, we are at a better position now on the growth front than, say, the USA. In the USA, in the quarter January to March 2022, the economy contracted by 1.4% over the previous quarter.
Consumer inflation in the US was 8.5% in March 2022, which eased to 8.3% in April 2022. In the US, the Federal Reserve is increasing interest rates rapidly. For an economy that is used to around 2% inflation, this is unbearable. Next year, the USA may face a recession due to increasing interest rates. In contrast, we are in a much better position. Growth has resumed after the pandemic-induced slowdown. Our economy can absorb the rate hikes, without impacting GDP growth to a significant extent.
Who in the RBI takes these interest rate decisions? There is a Monetary Policy Committee (MPC), comprising six people. Of this, three are officers from the RBI, the gGovernor and two designated officers — deputy governor / director. The other three members of the MPC are external experts, typically economists, nominated by the government. To be noted, the external members are independent and not government representatives in that sense, though they are nominated by the government. The MPC meets once every two months to discuss and decide on interest rates. Decisions can be taken out of turn also. The surprise rate hike on May 4 was one such unscheduled meeting, done in view of increasing inflation.
MPC’s minutes of the meeting
After an MPC meeting, the statement is released immediately on the RBI website. Subsequently, the minutes of the meeting are released, but after a gap. The minutes of the meeting held on May 4, 2022 was released on May 18, 2022. The minutes made the intention of the MPC members clear—in view of high inflation, they are going to increase the repo rate. Then the question is, to what extent? Nobody has the exact answer, as that will depend on the evolving trajectory of inflation in India.
As an illustration, if CPI inflation one year down the line is 6% or little more than 6%, then the repo rate may be expected to be somewhere around 6%, from today’s 4.4%. In the media conference after the policy announcement on April 8, 2022, the RBI deputy governor, as an illustration, mentioned the concept of net-of-inflation zero repo rate. As an example, if inflation is 4%, then 4% repo rate would make it net zero.
Drawing this logic, if inflation settles around, say, 6% one year or one-and-half year down the line, expectation on repo rate would be set accordingly. The next MPC meeting is scheduled for June 8, 2022, and the one after that is on August 4, 2022. Given that there is a time lag between the RBI increasing the signal repo rate and that passing on to the real economy, there are talks of front-loading rate hikes. That is, there is a higher probability of rate hikes in June and August 2022, and the MPC may go a little slower thereafter. However, as long as inflation does not settle down within 6%, which is the tolerance limit for the RBI, it cannot change course.
What does it mean for your investment portfolio? Though high inflation and increasing interest rates are not good for your investments, it is not something under your control. You do not need to react to or take action on everything. Let the market take its own course and you continue your investments as per your objectives of financial goals, time horizon and risk appetite.