RBI increases repo rate to 6.25%, loans to cost more now

The RBI may also have taken into account the fact that many other central banks in emerging markets too have raised rates in the face of rising inflation and weakening of their currencies with rising interest rates in the US and elsewhere, a strong US dollar and outflows.

Written by George Mathew , Khushboo Narayan | New Delhi | Updated: June 7, 2018 4:29:28 am
RBI monetary policy meet today The announcement was made after the Monetary Policy Committee (MPC), the rate-setting body of the RBI, completed its second bi-monthly review in Mumbai. (File)

Effecting the first hike since the NDA government came to power at the Centre, the Monetary Policy Committee (MPC) of the RBI on Wednesday raised its key policy rate, the repo rate, by 25 basis points to 6.25 per cent. This is expected to result in higher lending rates on housing, auto and other personal loans.

While all six members of the MPC voted in favour of the decision to increase the repo rate, the committee kept the policy stance neutral. The MPC, which met for three days this time as against two days during earlier policy reviews, cited a “major upside risk to the baseline inflation path with a sharp increase in crude oil prices and inflation expectation of households besides the impact of a revision on kharif crops which is expected soon”.

READ | Growth recovery has to be strong enough to compensate for rising rates, says expert

The RBI may also have taken into account the fact that many other central banks in emerging markets too have raised rates in the face of rising inflation and weakening of their currencies with rising interest rates in the US and elsewhere, a strong US dollar and outflows. What could have also prompted the rate action is an imminent increase in interest rates in the US with the world’s most powerful central bank, the Federal Reserve, set to meet next week to consider another rate hike.

The RBI last raised its policy rate — the rate at which it lends funds to banks — by 25 basis points to 8 per cent in January 2014. Since then, the central bank has adopted what is known as an accommodative stance and reduced the repo rate by 200 basis points to 6 per cent in the last four years, leading to a secular fall in interest rates. With the RBI repo rate increase, banks are likely to pass on the burden to consumers, which means that education, home, auto and other loans could get costlier.

RBI Governor Urjit Patel at the RBI headquarters after the announcement of a 0.25 per cent rate hike by the central bank in Mumbai on Wednesday. (Express Photo by Prashant Nadkar)

Earlier this week, some banks, including the State Bank of India (SBI), Punjab National Bank (PNB), HDFC and ICICI Bank increased their benchmark lending rates or MCLR by up to 10 basis points per cent, making loans costlier for consumers. SBI chairman Rajnish Kumar said that it was good that the rate hike has been done with now. He does not anticipate further rate hikes this year unless global oil prices rise. “This is the time that they could have done the rate hike “ he told The Indian Express.

Unveiling the bi-monthly monetary policy, RBI Governor Urjit Patel said, “Underlying the MPC decision was the fact that headline inflation has been sharper than anticipated, and has remained above the 4 per cent target for six consecutive months”. The RBI had kept rates on hold earlier as “impulses of growth were nascent and taking root”. Now a major upside risk has materialised with the 12 per cent increase in the price of Indian crude basket. “Crude oil prices have been volatile recently and this imparts considerable uncertainty to the inflation outlook — both on the upside and the downside,” MPC said.

Apart from this, a “significant” rise in the May 2018 households’ inflation expectation could “feed into wages and input costs” in the next few months. The May 2018 round of the Reserve Bank’s survey of households reported a significant rise in households’ inflation expectations of 90 basis points and 130 bps, respectively, for three-month and one-year ahead horizons. The RBI has revised upwards the retail inflation range to 4.8-4.9 per cent in the first half of 2018-19, and 4.7 per cent in the second half. The central bank has retained the GDP growth for the financial year 2018-19 at 7.4 per cent.

While all six members of the MPC voted in favour of the decision to increase the repo rate, the committee kept the policy stance neutral. (Express Photo by Prashant Nadkar)

On maintaining the neutral stance, Patel said, “a neutral stance leaves all options open and other central banks also do the same. So there is no contradiction or tension between the two (repo rate hike while maintaining a neutral stance). The committee felt that there was enough uncertainty for us to keep to the neutral stance and yet respond to the risks to inflation target that have emerge in recent months.”

The decision of the MPC is consistent with the neutral stance of monetary policy in consonance with the objective of achieving the medium-term target for consumer price index (CPI) inflation of 4 per cent within a band of plus or minus 2 per cent, while supporting growth, MPC said. The RBI listed several reasons for the rate hike. “Global financial market developments have emerged as another important source of uncertainty.

The staggered impact of HRA revisions by various state governments may push headline inflation up. While the statistical impact of HRA revisions will be looked through, there is a need to watch out for any second round impact on inflation. The impact of the revision in the MSP formula for kharif crops is not possible to assess at this stage in the absence of adequate details. As the forecast by the IMD, if the monsoon is normal and well-distributed temporally and spatially, it may help keep food inflation benign,” it said.

On various state governments announcing farm loan waiver schemes, Patel said, “farm loan waiver has been given through budget of individual state governments so far. Therefore, implications on the banks’ NPAs directly are not there.” While states like Maharashtra, Punjab, UP and Tamil Nadu had announced farm loan waivers last year, Karnataka and Rajasthan recently announced plans for farm loan waivers.

The MPC also cautioned that public finances should not crowd out private sector investment activity at this crucial juncture. “Adherence to budgetary targets by the Centre and the states — which appears to be the case thus far — will also ease upside risks to the inflation outlook considerably,” it said. The BSE Sensex rose by 276 points to 35,178.88 as interest rate-sensitive bank, auto and realty stocks rose by up to 3.5 per cent following the policy action by the RBI.

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