Monetary conditions tighten

The key policy development this month was the introduction of a new Standing Deposit Facility, through which the RBI will drain excess banking sector liquidity. The SDF now provides the floor for the interest rate corridor, previously set by the reverse repo rate. As it has been set higher than the reverse repo rate (3.75%, compared to 3.35%), interbank rates have risen. In other words, domestic monetary conditions have tightened. Looking ahead, the surge in inflation further above the ceiling of the RBI’s 2-6% target range suggests that further policy tightening is required. With the rate corridor now back at the width that the MPC desires, the next step will be to hike the both the repo rate the SDF rate simultaneously. We are forecasting a 25bp hike in both in June.