RBI Tightens its Monetary Policy; More in Offing

Effecting the first hike since the NDA government came to power at the Centre, the Reserve Bank of India (RBI) has raised its key policy rate, signalling the Monetary Policy Committee’s concern about inflation risks, mostly on account of higher input cost pressures.

The six-member Monetary Policy Committee (MPC) of the RBI in its first three-day bi-monthly policy meeting In June raised the key repo rate by 25 basis points (bps) for the first time since January 2014, in about four-and-a-half-years, to 6.25 per cent.

The last rate hike happened on January 28, 2014, when the repo rate was increased to 8 per cent. The last policy action was in August 2017, when the central bank had lowered the repo rate by 25 basis points.

Given underlying trends in inflation and financial markets, an interest rate increase this year was very much expected. RBI’s task is only going to get tougher in the months ahead. This is primarily on account of the need to support prospects for economic growth.

Further, the RBI once again has changed its inflation forecast, from 4.7-5.1 per cent for the first half and 4.4 per cent in the second half, to 4.8-4.9 per cent and 4.7 per cent, respectively. With MSP increases still not factored in, the acceleration of inflation in the second half can be more. According to the macro economic data, retail inflation rose sharply to 4.6 per cent in April from 4.3 per cent in March. Core inflation, which includes food and fuel, remained consistently high at 5.8 per cent in April, up from 5.23 per cent in March.

According to economists, the RBI might 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.

The immediate fallout of RBI’s rate hike would be that interest rates might begin to firm up. Banks have already been hiking lending as well as deposit rates over the past few months. Some banks have already raised MCLR (marginal cost of funds-based lending rate). The cost of borrowing will go up. But banks will also hike deposit rates and it will be good for savers.

However, the RBI has exercised caution and has kept the stance neutral lest it signals a sharp interest rate increase that could run a risk of throttling the growing recovery process. The neutral stance also allows RBI to remain extremely data-driven and thus fine-tune its rate decisions given a large number of uncertainties – both domestic and global. Given the uncertainties, it becomes difficult to gauge the RBI’s next move.

Economists expect RBI to increase at least one more time in 2018, and a maximum of two times. In the event of oil and the rupee remaining more or less at the current levels and with monsoons not playing truant, the RBI would be willing to skip any rate decision in August and shift any further tightening to October.

Latin Manharlal Group