Not everyone expected the Reserve Bank of India (RBI) to hike its policy rate on Wednesday, but its six-member monetary policy committee voted to do just that. Perhaps those who hoped for a status quo should look at this statement by RBI governor Urjit Patel at a press conference after the policy: “We have been away from 4% number for several months now. We took two steps, one in June and one in August, to maximize our chances that we don’t drift away from the target.”
The chart above shows why Patel made that statement.
Retail inflation, both at the headline level and for individual items, increased over the last three months. What is more relevant is that inflation rose faster in rural areas. At such a time, the hike in minimum support prices (MSPs) for kharif crops will only worsen this upward pressure on rural inflation.
Indeed, the central bank in its statement said the key reason for the rate hike was the proposed increase in MSPs and its impact on the headline inflation number. That said, RBI concedes it is challenging to accurately gauge the impact as it would depend on the procurement of crops by the government over the second half of this year.
Even so, the central bank wins points for hiking rates proactively by pre-empting the impact. After all, monetary policy measures work with a lag. Even as farmers are likely to benefit from higher prices and thereby increase consumption, the pricing power of corporates is likely to strengthen too. This means rising input costs could be passed on to customers by companies as economic growth improves. RBI has sounded sanguine on growth pointing to the rise in bank credit, robust commercial vehicle sales and improving construction activity.
Also read: RBI frontloads rate hike, more on the cards
Add to this mix sticky and rising core inflation and there is a perfect recipe for a rate hike. Some analysts expect another one in the rest of FY19, considering that upside risks are unlikely to abate by then.
Since RBI cannot ignore threats from trade tensions between the US and China and volatile financial markets, it has maintained the neutral policy stance. But in all respects, the central bank’s policy statement was anything but neutral.
The rate hike was well taken by the market given that bond yields hardly budged, the exchange rate behaved and rate-sensitive stocks fell only marginally. While loan rates may go up, it is unlikely to disrupt borrowing in a big way.