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August 01, 2018

A forward-looking move

  • 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). The move comes close on the heels of a 25 bps hike effected in June. With this, the repo rate stands at 6.50%, the reverse repo at 6.25%, and the marginal standing facility rate at 6.75%. Five of the six members of the MPC supported the resolution.
  • The decision to hike is based on two factors: i) a sustained and broad-based rise in core inflation (headline excluding food and fuel), reflecting strong demand conditions and ii) future upside risks to overall inflation
    • Both headline and core inflation have inched up since the last policy meet. While overall CPI inflation reached 5% on-year in June, core inflation touched 6%. Along with this, inflation expectations have continued to surge. “The June round of the Reserve Bank’s survey of households reported a further uptick of 20 basis points in inflation expectations for both three-month and one-year ahead horizons as compared with the last round,” the RBI noted. The virtual closing of output gap, as pointed out by RBI, entails rising cost push pressures ahead.
    • Given the government’s decision to fix the minimum support prices (MSPs) at a minimum 150% of the cost of production for all kharif crops for sowing season 2018-19, the MPC revised up the CPI inflation forecast for the second half of fiscal 2019 by 10 bps to 4.8%. But it also cited uncertainty on the exact impact, which would depend on the efficacy of the government’s procurement operations. The GDP forecast for fiscal 2019 was left unchanged at 7.4%.
    • Despite the rate hike, the MPC maintained its neutral monetary policy stance, with a focus on keeping medium-term inflation at 4%. The neutral stance implies it has kept options open given the uncertainty on the inflation trajectory. The MPC will therefore remain vigilant on this front.