Mumbai: The Reserve Bank of India’s (RBI’s) monetary policy committee (MPC) on Wednesday voted unanimously to raise policy rates by 25 basis points to 6.25%, the first such hike in more than four years, as inflation concerns mounted.
The six-member committee also voted to keep its policy stance neutral, keeping its options open for further rate hikes.
The decision was contrary to market expectations that the central bank would hold rates but change its stance to hawkish from neutral. A survey of 15 economists by Mint showed that only four expected RBI to raise rates.
Supporting the rate hike was an increase in the inflation forecast. RBI now expects average inflation for 2018-19 to be 4.8-4.9% in the first half and 4.7% in the second half. In the previous policy in April, the central bank had forecast average inflation to be 4.7-5.1% for the first half of the current fiscal year, thereafter slowing to 4.4% in the second half. Inflation has remained above RBI’s medium-term target of 4% for the past six months.
The policy statement cited several factors that could stoke inflation, including an increase in crude oil prices, rise in household inflation expectations, hardening of wages and input costs, and the impact of higher house rent allowance for employees of various state governments. The committee warned that the impact of a revision in minimum support prices (MSP) is uncertain due to lack of adequate details.
“Since the MPC’s meeting in April, the price of Indian basket of crude has surged from $66/bbl to $74/bbl. This, along with increase in other global commodity prices and recent global developments, has resulted in firming up of input cost pressures and persistent higher CPI projection of 2018-19. In the MPC’s view, the price of Indian crude basket imparts considerable uncertainty to the inflation outlook both on upside and downside," said governor Urijit Patel.
Given these inflationary risks, economists expect one more rate hike, the timing of which will be dependent on the government’s MSP announcement.
“We remain confident that this will be a shallow rate hike cycle if the present conditions do not deteriorate significantly. We expect RBI to hike by another 25 bps in the August policy but the call will hinge on how crude and INR movements pan out over the next few months, as well as the extent of MSP hikes," said Suvodeep Rakshit, a senior economist at Kotak Institutional Equities.
MPC noted that its decision to hike rates was premised on the sustained revival in economic activity. The panel retained its forecast of 7.4% growth in GDP for 2018-19. Growth is likely to be 7.5-7.6% in the first half of the fiscal and 7.3-7.4% in the second half. The MPC sounded optimistic on investment and noted that consumption demand remains strong.
Bond yields rose 8 basis points to close at 7.9% following the rate hike, while the BSE’s benchmark Sensex gained 0.79% due to the stance being kept neutral.
The decision to hike rates was unanimous with all members of the MPC, including Ravindra Dholakia and Pami Dua, known for their dovish stance, voting for a rate hike.
The rate hike may not result in an immediate increase in deposit or lending rates as some lenders have already increased rates.
Moreover, bankers believe that the RBI’s move to include a higher proportion of statutory liquidity ratio (SLR) securities under liquidity coverage ratio may keep short-term rates in check.
“RBI’s decision to allow banks to dip into SLR will improve liquidity in the system because of reduced demand for government securities. This will result in short term rates cooling off. We, therefore, do not expect deposit rates to go up in the immediate future. Since MCLR is dependent on one-year deposit rate, a further hike in lending rate looks unlikely," said C. Venkat Nageswar, deputy managing director, State Bank of India.