Economics Prelims cum Mains

What RBI’s rate hikes indicate?

The News

  • The six-member monetary policy committee (MPC) of the Reserve Bank of India (RBI) increased the repo rate by 25 basis points to 6.25%.

 

Policy announcement:

  • The Monetary Policy Committee (MPC) of the Reserve Bank of India (RBI) is the central bank’s rate-setting panel. The committee has raised the repo rate (the short-term lending rate at which it lends money to commercial banks) by 25 basis points. (One basis point is one-hundredth of a percentage point.)
  • While the central bank has increased the inflation projection, it has maintained the ‘neutral’ stance for monetary policy, meaning interest rates can move either way i.e. the options remain open as uncertainty continues on the inflation trajectory.
  • This was the first time interest rates were increased after more than four years and rates had been on hold since the last cut in August 2017. So this effectively signalled the end of the rate-easing cycle for now.

 

 

Reason for increase

Increase in inflation

  • The rate hike was clearly prompted by the upside risk to inflation projections on account of:
    • Sharper-than-expected uptick in both headline inflation and core inflation (inflation excluding food and fuel components).
    • 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.

 

Other factors:

  • Commodity prices:
    • While the summer momentum in vegetable prices is “weaker than the usual pattern”, the panel noted that the sudden 80 basis-point acceleration in core inflation suggested a hardening of underlying inflationary pressures.
    • Alongside the increase in other global commodity prices, pointing to a firming of input cost pressures.
  • Crude Oil:
    • Another major upside risk is the sharper-than-expected 12% increase in the price of the Indian crude basket ($ 66 per barrel to $ 74).
    • Crude oil prices have been volatile and this imparts considerable uncertainty to the inflation outlook — both on the upside and the downside.
  • MSP:
    • 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.
  • HRA: The impact of an increase in house rent allowance (HRA) for central government employees has also been factored into the inflation estimates this fiscal.

 

Impact of rate hike:

  • 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.

 

Future trend:

  • 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.
  • For the remainder of 2018-19, analysts see the possibility of a further hike of 25-50 basis points if oil prices and US Treasury yields continue to rise.
  • The monsoon’s progress, MSP increases, and the government’s adherence to its fiscal policy target will also be crucial.

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