Swati Bhagat and Nupur Aanand

MUMBAI, Reuters -The Reserve Bank of India increased its key lending rate 40 basis points to 4.40% Wednesday in an effort to control rising inflation. Markets were taken by surprise by the unexpected meeting of its monetary committee.

In addition, the central bank raised the banks’ cash reserve ratio (or proportion of their deposits required to be set aside by RBI as cash) by 50 basis points. This was effective from May 21st 2022.

MPC members unanimously declared that despite tightening, they would maintain an accommodative approach to growth.

In a virtual address to the media, Governor Shaktikanta Die announced the first repo rate change in over two years.

Das stated that “The MPC believed that inflation forecast warranted a timely and appropriate response via resolute, calibrated steps to ensure that second-round shocks to the economy from supply are contained”

His statement said that price stability would make the greatest contributions to macroeconomic and financial stability, as well as sustainable economic growth.

When the economy was in turmoil from the pandemic’s onset, the repo rate (the rate banks can borrow from RBI) was reduced to an all-time low in May 2020. The rate was maintained at the same level last month at an MPC meeting.

Analysts had predicted that rates would be increased at the June 6-8 meeting of the 6-member panel. However, the MPC’s meeting this week caught the financial markets by surprise. The repo rate had been raised by the RBI in August 2018, which was the last time it did so.

Ajay BODKE, an independent market analyst stated: “RBI felt compelled by the circumstances to restore its rapidly eroding credibility”

India’s benchmark 10-year bond yield rose to 7.42% in India, the highest since May 2019. The rupee also strengthened against the dollar at 76.26

Many traders believed that the RBI wanted to take action before the U.S. Federal Reserve’s meeting. Analysts expect the Fed’s rate hike to be 50 basis points.

Retail inflation in India accelerated to almost 7% in March. This is its highest level in 17 months, and it was above the limit of RBI’s tolerance range of 2-6% for a third consecutive month. Medium term inflation targets for the RBI are 4%.

Das explained that inflation spike was mostly due to high food prices. Prices are expected to stay at this level for the near future. Next week will see the release of April inflation data.