Second time in two months, RBI increases interest rate, cautions on fiscal front

The rate hike in June was the first time the benchmark lending rate was raised in over four years. This is now the first time since October 2013 that the central bank has raised the repo rate at two consecutive policy meetings.

By: ENS Economic Bureau | Mumbai | Updated: August 2, 2018 4:50:38 am
Urjit Patel, Urjit Patel RBI, Urjit Patel demonetisation, Urjit Patel India growth, Urjit Patel inflation, RBI inflation, RBI demonetisation, Monetary Policy Meet RBI, Business news RBI Governor Urjit Patel (File Photo)

The Monetary Policy Committee or MPC of the Reserve Bank of India Wednesday raised its key policy rate — the repo rate — by 25 basis points for the second time in two months to contain inflation in a year leading up to general elections.

Indicating that the RBI is taking a long-term view on inflation “while supporting growth” and retaining its “neutral stance”, the central bank, in its third bi-monthly monetary policy of the current fiscal, raised the repo or the rate at which it lends to other banks, by 0.25 per cent to 6.5 per cent which is expected to lead to higher interest rates on housing, auto and other personal loans.

The rate hike in June was the first time the benchmark lending rate was raised in over four years. This is now the first time since October 2013 that the central bank has raised the repo rate at two consecutive policy meetings.

The six-member MPC, headed by RBI Governor Urjit Patel, kept its stance at neutral with five members voting in favour of the decision to increase the repo rate and one member — Ravindra Dholakia — against the rate hike.

READ | RBI warns of persisting inflation risks, projection at 4.6 per cent in Q2

Unveiling the bi-monthly monetary policy, Governor Patel said, “The monetary policy committee observed that since its meeting in June, global growth has sustained pace but it has become uneven. Volatile oil prices, mounting trade tensions and the tightening of financial conditions have increased. Inflation has added up in several major advanced and emerging economies driven by rising energy crisis and the pass-through from respective currency volatility.”

Patel said financial markets remain unsettled, and capital flows to emerging economies have declined with currencies depreciating against the firming US dollars. On the domestic front, the MPC took note of the rise in retail CPI inflation for the third consecutive month in June. Even though food inflation remained muted, other components recorded moderate to sharp price increase. “Households reported an uptick in inflation expectations while manufacturing and services firm indicated elevated input costs and wage growth in the organised sector remained firm.”

For July-September, the RBI pegged CPI-based retail inflation at 4.2 per cent, which it saw firming up to 4.8 per cent in the second half of the current fiscal. The projected inflation rate is above its targeted comfort level of 4 per cent. The RBI retained the GDP forecast for the current fiscal at 7.4 per cent on robust corporate earnings and buoyant rural demand, though it flagged global trade tensions for Indian exports. It also saw the GDP forecast at 7.5-7.6 per cent in the second half of the current fiscal.

Retail inflation has been projected to rise further to 5 per cent in the first quarter of next financial year 2019-20. “The inflation outlook is likely to be shaped by several factors. First, the central government has decided to fix the minimum support prices (MSPs) of at least 150 per cent of the cost of production for all kharif crops for the sowing season of 2018-19. This increase in MSPs for kharif crops, which is much larger than the average increase seen in the past few years, will have a direct impact on food inflation and second round effects on headline inflation,” RBI said in its policy review.

On an MSP hike, RBI said there is considerable uncertainty and the exact impact would depend on the nature and scale of the government’s procurement operations.

“As such, only the incremental increase in MSPs over the average increase in the past will impact inflation projections. Second, the overall performance of the monsoon so far augurs well for food inflation in the medium-term. Third, crude oil prices have moderated slightly, but remain at elevated levels. Fourth, the central government has reduced Goods and Services Tax (GST) rates on several goods and services,” the RBI said.

This will have some direct moderating impact on inflation, provided there is a pass-through of reduced GST rates to retail consumers, it said.

Cautioning on the fiscal front, the RBI said, “in case there is fiscal slippage at the centre and/or state levels, it could have adverse implications for market volatility, crowd out private investment and impact the outlook for inflation.”

Reacting to the rate hike, former Finance Minister P Chidambaram said, “back-to-back increase is because the RBI does not believe the government’s projections on inflation and fiscal deficit. The RBI wishes to contain inflation as well as discourage the government from exceeding the borrowing target in an election year.”

State Bank of India Chairman Rajnish Kumar said the RBI decision to raise repo rate by 25 bps for the second time in succession is a “clear desire to frontload the rate hike cycle”.

“Simultaneously, the decision to keep the stance in neutral mode indicates the RBI willingness to be flexible and accommodative with global growth continuing to be uncertain,” Kumar said.

RBI Deputy Governor Viral Acharya said on most days in June and July, the liquidity in the system has remained in a neutral zone, which is consistent with the projection of the RBI in the last policy.

“The system, however, is still in a small surplus on average and this is also reflected in the fact that the overnight lending rates and the weighted average call rate, which we monitor closely in determining our transient liquidity management, has remained on an average ten basis points below the policy rate during the June and July period though it has come down from 14 basis points during April and May,” Acharya said.

He said though the growth in currency in circulation has moderated to some extent recently, its expansion has remained above historical trend.

“Reserve money growth is expected to pick up in the second half of fiscal year 2018, it’s usually co-incident with the start of the festive season. RBI will continue to actively manage the system liquidity so as to achieve the monetary policy objective of aligning the overnight weighted average call rate with the policy rate while meeting the economy’s demand for reserve money growth,” Acharya said.

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