MUMBAI - The Reserve Bank of India kept its key lending rate at a record low on Friday, as expected, but said it will turn its focus to battling inflation as the Russia-Ukraine crisis pushes crucial commodity prices to near-record highs.
In a surprise move, the central bank also said it would restore a liquidity adjustment tool to pre-crisis levels, which was seen as a first step to moving away from the ultra-loose monetary policy embraced during the COVID-19 pandemic.
But with global risks rising, RBI Governor Shaktikanta Das said the process of returning policy settings to more normal levels would be gradual.
"The conflict in Europe has the potential to derail the global economy caught in the crosscurrent of multiple headwinds. Our approach needs to be cautious, but proactive in mitigating the adverse impact on India's growth and inflation," Das said after the policy decision.
The RBI's monetary policy committee held the lending rate, or the repo rate, at 4%. The reverse repo rate , or the key borrowing rate, was also kept unchanged at 3.35%.
However, the central bank said it would restore the width of the liquidity adjustment facility corridor to 50 basis points.
RBI said the floor of the corridor would be the standing deposit facility rate, which was set at 3.75%, and the marginal standing facility rate at 4.25% will be the upper bound with the repo rate in between the two.
"The hawkish turn by the RBI was warranted and it is likely that central bank will change its stance to neutral in the coming policy (meeting) followed by a repo rate hike sooner than earlier expected," said Sakshi Gupta, senior economist at HDFC Bank.
All but six of 50 respondents polled by Reuters between March 29-April 5 forecast no change in the repo rate on Friday. Thirty-two had expected rates to still be unchanged by end-June.
"INFLATION BEFORE GROWTH"
Reflecting growing uncertainties, the RBI raised its inflation forecast for the current fiscal year to 5.7%, 120 basis points above its forecast in February, and cut its economic growth forecast to 7.2% for 2022/23 from 7.8% earlier.
"We have now put inflation before growth. So that is the sequence of our priorities - first is inflation followed by growth," RBI Governor Das said. He added that this is the first time in three years that it was putting inflation in the forefront.
Das said RBI will gradually withdraw system liquidity over a multi-year timeframe beginning this year but will do it in a non-disruptive manner. He said economic activity is barely above pre-pandemic levels but continues to steadily recover.
Das said the MPC voted unanimously to keep the repo rate unchanged and to retain an 'accommodative' monetary policy stance.
But he added that even though the stance remained 'accommodative' the focus is on withdrawal of accommodation.
Inflation has held above the RBI's 6% upper threshold so far this year, casting doubt on its strategy of keeping rates low to bolster growth even as some other central banks are already raising borrowing costs to tamp down price pressures.
India's 10-year benchmark bond yield jumped to 7.048%, while the rupee strengthened as much as 75.71 against the dollar. The NSE Nifty 50 index was up 0.48% at 17,724.75, as of 0703 GMT, while the S&P BSE Sensex was up 0.37% at 59,256.26.
Das also said that banks' held-to-maturity limit in debt has been increased to 23% from the current 22% until end-March 2023.
Traders have been closely watching for any measures to support the bond market in absorbing the government's record $14.31 trillion borrowing programme.
"Amid inability to explicitly support the government borrowing program, the RBI enhanced the held-to-maturity limit by 100 bps, which could calm the bond markets despite a sharp increase in inflation forecast," said Garima Kapoor, economist institutional equities at Elara Capital.
(Additional reporting by Sethuraman N R; Editing by Kim Coghill)