Inflation-spooked RBI goes for second straight rate hike
Key rate raised by 25bps to 6.5% with neutral policy stance; option open for further hikes
Mumbai: The Reserve Bank of India (RBI) resorted to a back-to-back interest rate hike for the first time in almost five years to curb inflation and pre-empt a rout of the rupee as the global trade war escalates.
The central bank’s six-member monetary policy committee on Wednesday voted 5-1 to raise policy rates by 25 basis points to 6.5%. This is the first time since October 2013 that RBI has raised rates in consecutive meetings of its rate-setting panel. It raised interest rates by 25 basis points in its June meeting. The rate action was in line with the expectations of economists surveyed by Mint.
The possibility of another rate hike this financial year remained as RBI governor Urjit Patel reiterated his intention to stick to the 4% inflation target and indicated upside risks to the target because of the larger-than-average increase in minimum support price (MSP) for summer-sown crops and volatility in crude oil prices.
“We have been away from the 4% (CPI) target for several months now. And we took two steps. One in June and one in August to maximize our chances that we don’t drift away from 4% and we move towards 4% on a durable basis,” Patel said.
The MSP hike is the primary factor stoking inflation this year, RBI said. The government has fixed MSP at 150% of the cost of production of all kharif crops.
“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 statement.
RBI also highlighted its concerns over crude oil prices, which remain elevated, despite seeing a slight moderation.
While some economists expect RBI to pause, others are not ruling out more than one hike before the end of the financial year.
“Given the upside risks to inflation, discussed extensively, another policy rate hike cannot be ruled out. However, if there is an escalation in trade war risks and a resultant global output compression then the RBI could be prompted to stay on a prolonged pause,”said Abheek Barua, chief economist, HDFC Bank Ltd.
On growth outlook, RBI remains confident of strong economic growth supported by monsoon, strong rural demand due to MSP hike and rising investments.
“The MPC notes that domestic economic activity has continued to sustain momentum and the output gap has virtually closed,” said the policy statement.
The committee also voted to keep its policy stance neutral, keeping its options open for further rate hikes. One reason for the neutral stance was the potential impact of trade tensions between the US and China.
“Few months of turbulence are now behind us. It looks like this is likely to continue. Trade skirmishes evolved into tariff wars. We are possibly at the beginning of a currency war,” said Patel.
The decision of the MPC was not unanimous, unlike the previous policy, with Ravindra Dholakia voting against the decision.
Banks are preparing to pass on the higher rate to borrowers. With the country’s largest lender, State Bank of India, having raised its long-term deposits rates, other banks may follow suit.
“Rate transmission will happen over the next few months, but expect both deposit and lending rates to go up,” said Shyam Srinivasan, managing director and chief executive of Federal Bank.
Bond yields remained little changed after the rate hike announcement, with the yield on the 10-year benchmark falling by 6 basis points to close at 7.7% on Wednesday. BSE’s benchmark Sensex stock index fell 0.23% to 37,521.62.
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