RBI increase its interest rates

• The Monetary Policy Committee (MPC) of the Reserve Bank of India (RBI) has raised the repo rate by 25 basis points.
• This was the first-time interest rates were increased since the NDA government came to power in May 2014, and effectively signalled the end of the rate-easing cycle for now. Rates had been on hold since the last cut in August 2017.

Analysis:

• The rate hike appeared to be a precautionary move against the backdrop of global volatility in crude and elevated commodity inflation worldwide.
• It was contrary to the broader market expectation that the RBI would hold rates while revising its stance from ‘neutral’ to ‘tighten’, and came as a reassertion by the bank of its inflation-targeting role, and a signal that it did not want to fall behind the curve on its primary mandate.
• The June hike — which proved wrong the belief that the bank would wait until its August policy review to reset rates — indicated the preference for an early start in dealing with inflationary pressures that are now quite visible.
• The rate hike was clearly prompted by the upside risk to inflation projections on account of (a) sharper-than-expected uptick in both headline inflation and core inflation (inflation excluding food and fuel components), and (b) fresh indicators on the robustness of domestic growth revival.
• The central bank now expects average inflation to be 4.8%-4.9% in the first half of 2018-19, and 4.7% in the second half of the financial year.
• In its previous monetary policy meeting two months ago, the RBI had projected average inflation at 4.7%-5.1% for first half of the current fiscal, and a much lower 4.4% for the second half of the year.
• Another major upside risk is the sharper-than-expected 12% increase in the price of the Indian crude basket ($ 66 per barrel to $ 74) since April, alongside the increase in other global commodity prices, pointing to a firming of input cost pressures.
• While the RBI has noted that the impact of the proposed revision in the minimum support price (MSP) formula for kharif crops cannot be assessed “in the absence of adequate details”, analysts predict that if the 50% plus MSP is announced, it could increase rice MSP by 18%, adding to the upside risks. The impact of an increase in house rent allowance (HRA) for central government employees has also been factored into the inflation estimates this fiscal.
• With RBI raising the repo rate, banks are likely to pass on the burden to consumers, which means education, home, auto and other loans could get costlier. Earlier this week, banks including SBI, PNB, HDFC Bank and ICICI Bank raised their benchmark lending rates, or MCLR, by up to 10 basis points, making loans costlier.
• The hardening of market interest rates in India mirrors the trend in Asia, where a number of central banks have raised policy rates in response to weaker currencies and tighter global capital flows. Turkey, the Philippines and Indonesia have delivered a preemptive rate hike during the course of the year. In March, China raised a key short-term rate after the US Federal Reserve hiked rates.

By: Vishal