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June 06, 2018

Pulling the trigger

  • The Reserve Bank of India’s (RBI’s) Monetary Policy Committee (MPC), at the end of its review meeting today, raised policy rates by 25 basis points (bps). Rates had been kept on hold since the last rate cut in August 2017. With this, the repo rate stands at 6.25%, the reverse repo at 6%, and the marginal standing facility rate at 6.5%. All six members of the MPC unanimously supported the resolution.
  • The decision to hike is based on two factors: i) a sharper-than-anticipated pick-up in not just headline inflation, but also core inflation (headline excluding food and fuel), and ii) evidence on soundness of domestic growth revival.
    • The main worry is that core inflation (even after excluding the impact of house rent allowance revision) jumped 80 bps to 5.3% in April. This not only reflects the sharp increase in oil prices over that period, but also other input cost pressures faced by manufacturers due to firmer metal prices and a weaker rupee – which they have possibly begun to pass on to consumers as domestic demand conditions improve.
    • A note of caution was sounded on persistence and pass-through of input price shocks into generalised inflation given that headline inflation has been higher than MPC’s medium-term target of 4% for six successive months. This is also reflected in the latest survey of households’ inflation expectations, which saw a significant rise. Rising household inflation expectations pose a threat as these can potentially enter wage negotiations and become generalised.
  • The MPC accordingly raised its average inflation forecast up mildly, by 10 bps, to ~4.8% for fiscal 2019. The GDP forecast was left unchanged at 7.4%.
  • Despite the rate hike, the MPC maintained its neutral monetary policy stance with a focus on maintaining medium-term inflation at 4%. The neutral stance mainly implies that options are left open as uncertainty remains on the inflation trajectory. The MPC will therefore remain vigilant on this front.