As expected by most economists and analysts, the Reserve Bank of India (RBI) on Wednesday raised the repo rate by a quarter percentage point to 6.5%, the second such hike in two months, making money more expensive in the world’s fastest growing major economy, but the Indian central bank’s monetary stance remains unchanged—neutral.
Logically, two successive rate hikes indicate the beginning of a rate-hiking cycle even though there is no certainty on when will RBI go for its next rate hike. In other words, one should not read too much into its neutral stance; its action will depend on the incoming data and developments—both domestic and external.
In some sense, RBI has frontloaded the rate hike to dampen inflationary expectations.
RBI deputy governor Viral Acharya’s comment at the post-monetary policy press conference that the impact of the rate hikes is felt with a lag effect gives one the impression that the next rate hike may not happen too soon—not at least in the next meeting of RBI’s monetary policy committee (MPC) in October. This is why the bond prices rallied even after the rate hike announcement. A drop in oil price during the day also contributed to the bond rally.
The central bank sees too many risks and uncertainties all around. Even though the economic activities globally continued to maintain steam, the pace of growth has become uneven and risks have increased on account of escalating trade war which may lead into currency war, high and volatile oil prices, and tightening of financial conditions.
On the domestic front, south-west monsoon has been recovering after a brief spell of deficiency in the second half of June. However, there is a considerable uncertainty surrounding the central government’s decision to raise the minimum support prices (MSPs) of at least 150% of the cost of production for all kharif crops. While a part of the increase in MSPs, based on historical trends, has been included in the RBI’s inflation projections, the exact impact would depend on the nature and scale of the government’s procurement operations.
Indeed, the reduction in Goods and Services Tax (GST) rates on several items will likely to have some positive impact on inflation but the significant rise in the so-called core inflation or non-food, non-fuel inflation has been broad, signaling rising input costs and improving demand.
This is possibly why RBI has frontloaded the rate hike. Also, keeping all these in mind, it has raised the retail inflation projection marginally from 4.7% to 4.8% in the second half of current fiscal year and 5% in the first of next fiscal year, 2020, with risks “evenly balanced”.
Its GDP growth projection for the current year, however, remained unchanged at 7.4% but for the first half of next year, it has projected a marginally higher 7.5% GDP growth. The monetary policy committee has noted that domestic economic activity has continued to sustain momentum and the output gap has virtually closed.
Both the monetary policy document as well as RBI governor Urjit Patel repeatedly emphasized on the MPC’s objective of maintaining the retail inflation target at 4% on a durable basis. Against this backdrop and the raise in projection of inflation in the first half of next fiscal year and the central bank’s worry about fiscal slippage and rupee depreciation, it is for certain that the latest rate hike is not the last in Asia’s third largest economy. There will be more rate hikes. How many and when are anybody’s guess at this point in time. The neutral stance does not say much on the future course of action.
Tamal Bandyopadhyay, consulting editor at Mint, is adviser to Bandhan Bank. His Twitter handle is @tamalbandyo.
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