The Reserve Bank of India (RBI) logo is displayed outside of the bank’s headquarters in Mumbai. (Photographer: Kainaz Amaria/Bloomberg)

Economists See Shallow Rate Hike Cycle As MPC Stays ‘Neutral’

India’s monetary policy committee today hiked benchmark lending rates against a backdrop of rising inflation, higher oil prices and a weak currency and kept a ‘neutral’ policy stance.

The six-member committee unanimously voted to raise the repo rate by 25 basis points to 6.25 percent and increased the reverse repo rate to 6 percent from 5.75 percent earlier. Fourteen of 43 economists polled by Bloomberg had forecast a 25 basis point hike in key rates.

The hike in interest rates signals an intent to keep inflation in check in the face of the oil supply shock, economists and bond market experts said.

‘Shallow Rate Hike Cycle'

Kotak Mahindra Bank sees the policy decision as a reaction to the recent movement in crude prices and rupee, it said in a note today. But the bank is confident that this will be a “shallow rate hike cycle” given the MPC’s decision to maintain the policy stance at neutral. “Possibly, a rate hike in August will be likely be the last one, for now,” it added.

Also read: MPC Hikes Interest Rates For The First Time In Over Four Years  

‘A Dovish Hike’

The RBI’s decision to maintain a neutral stance suggests that it does not want to signal that it is embarking on a tightening cycle and that it remains data dependent, Nomura said in a report.

“Both growth and inflation are likely to head higher in the coming months, paving the way for another 25 bps rate hike in August,” the authors of the report said.

However, higher oil prices and political uncertainty are likely to slow down economic activity after September, they added.

Also read: Household Inflation Expectations Shoot Up In May

One More Hike In Store In FY19

The MPC’s rate hike decision was likely prompted by domestic inflation and inflationary build up coupled with U.S. Federal Reserve’s stance on unwinding of its balance sheet and guidance on Fed rates, said Devendra Kumar Pant of India Ratings.

Domestic factors such as the impact of the revision in house rent allowance by state governments and the revision in minimum support prices will impact inflation and inflationary expectations in the near term. Pant said in an emailed note. Besides, higher oil prices globally have already “begun to seep into the Indian economy” as retail prices of petrol reached an all-time high on May 29, he added.

With this hike RBI has already signaled a reversal on policy rates, India Ratings said, adding that “one more may be in store during FY19”.

A 25 Bps Hike In October Hike Likely

Sajjid Chinoy of JPMorgan agreed that more hikes may be in store this year, including a 25 basis point hike in October, if global oil prices were to stabilise at current levels.

“August is too soon but October seems more likely by which time we will have better information about what the impact of the MSPs on food prices, unless the global environment turns adverse and they have to move quickly,” Chinoy, chief India economist at JPMorgan told BloombergQuint in an interview.

Considering that the growth will not be “gangbuster” this year due to the pressure of higher crude oil prices, a total 50 basis point hike during the year would be enough, he added.

What could change that?

“If oil were to go up by $10-15 per barrel, or the MSP increases tend to become more inflationary than we expect, then it would create upside risks to what the RBI has to do,” Chinoy said.

Also read: Bonds in India Slide as RBI Raises Benchmark Rate, Rupee Climbs

‘Next Hike Data Dependent

There is a possibility of another 25 basis point hike between now and December, said Keki Mistry, chief executive officer of mortgage lender HDFC, adding that it will be data dependent.

“Wouldn't rule out another hike by December,” Mistry told BloombergQuint. But it “depends on on oil prices, it depends on US interest rates, how the monsoons pan out, on commodity prices”, he added.

‘Surprise Move’

The timing of the MPC’s decision is a “surprise” for Sanjeev Prasad, of Kotak Institutional Securities. That’s because the last 9-12 months have seen a fairly big increase in both corporate bond yields and government bond yields, he told BloombergQuint.

“We were expecting the RBI to raise rates by nearly 50 basis points in the second half of this calendar year. In a way, the markets were assuming that the RBI will raise rates,” Prasad said.

The outlook for financial year 2019 however is tricky, he added, given the fairly weak macro backdrop and political uncertainty ahead of the general elections next year.

Also read: RBI Extends Temporary Loan Repayment Relief For Small Businesses

‘No Incremental Impact On Bonds’

Bond yields have inched up in the past few months, and banks and housing finance companies have already increased lending rates, said Macquarie Research in a note. “So there is no incremental impact from today’s rate hike, but it is at the margin a sentiment negative for market interest rates,” it added.

Any further rise in bond yields will impact wholesale borrowers, especially non-banking financial companies and housing finance companies, and hurt treasury portfolios of state-owned banks, the note said.