People stand in line at the Reserve Bank of India headquarters in New Delhi, India. (Photographer: Anindito Mukherjee/Bloomberg)

India Monetary Policy: MPC Hikes Rates For Second Straight Time


*MPC hikes repo rate by 25bps to 6.5%
* MPC hikes reverse repo rate by 25 bps to 6.25%
* MPC maintains ‘Neutral’ stance on policy
* MPC voted 5-1 in favor of a rate hike
* CPI inflation seen at 4.6% in Q2, 4.8% in H2 FY19, 5% in Q1 FY20
* GDP growth forecast retained at 7.4% for FY19
* Banks, NBFCs allowed to co-originate loans for priority sector

India’s Monetary Policy Committee decided to raise the benchmark interest rate by 25 basis points at its meeting concluded on Wednesday, while retaining a 'Neutral' monetary policy stance.

The committee voted 5-1 to hike the repo rate from 6.25 percent to 6.5 percent. Committee member Ravindra Dholakia voted against the resolution.

The decision was in line with expectations. Of the 53 economists polled by Bloomberg, 40 had forecast a rate hike at the August policy meeting.

The MPC had hiked rates for the first time in four years in June to quell price pressures and bring inflation closer to the mid-point of the committee’s target of 4 (+/- 2 percent). Explaining its decision, the MPC said it is "consistent with the neutral stance of monetary policy in consonance with the objective of achieving the medium-term target for consumer price index (CPI) inflation of 4 per cent within a band of +/- 2 per cent, while supporting growth."

RBI Governor Urjit Patel reiterated the MPC’s intent to stick to the 4 percent inflation target in a press conference right after the meeting. “The main reason for changing the policy rate is to ensure that on a durable basis we come to and maintain the 4 percent target. And we've been away from the 4 percent target for several months now,” he said.

“We took two steps, one in June and one in August, to maximise our chances that we don't drift away from 4 percent and in fact we move towards 4 percent.”

Outlook On Inflation

While not making a material change to its range of inflation projections, the MPC said that it expects inflation at 4.6 percent in Q2, 4.8 percent in H2 of 2018-19, and 5.0 percent in Q1 2019-20. Risks to these forecasts are evenly balanced, said the MPC.

Core inflation inched up to 6.3 percent in May vs 6.1 percent in April. Headline inflation rose to 5 percent. Those arguing for a rate hike had highlighted that higher core inflation is reflecting both cost pressures from higher input prices and demand pressures due to a strengthening economy. Some fresh upside risk to inflation has also emerged due to an announcement of higher Minimum Support Prices (MSP) for the Kharif season.

"This increase in MSPs for kharif crops, which is much larger than the average increase seen in the past few years, will have a direct impact on food inflation and second round effects on headline inflation," said the MPC. It, however, added that there is considerable uncertainty about the exact impact of the higher MSPs on inflation due to uncertainty around the level of procurement undertaken at the higher support prices.

The MPC added that other factors such as the possibility of higher oil prices, volatility in global financial markets and rising inflation expectations could also impinge on actual inflation outcomes. "…in case there is fiscal slippage at the centre and/or state levels, it could have adverse implications for market volatility, crowd out private investment and impact the outlook for inflation," the MPC added.

Bond Market Reaction

The benchmark ten year bond yield rose to 7.85 levels right after the MPC decision was announced but has since declined. Mostly on the RBI Governor Urjit Patel’s reiteration that the MPC’s stance remains “neutral”.

Many of the risks we have cited in our projections are on both sides. And that’s why we’ve said that these projections are against the backdrop of balanced risks. Secondly, there is a fair bit of uncertainty around the CPI prints going forward and therefore it was important that we kept our options open depending on the prints coming in over the next few months, given the volatility of the prints that have been coming in. So that’s why we emphasise that we would need to monitor the domestic inflation outlook in the coming months very carefully. For these reasons, the stance is retained at neutral and the risks around the projections are balanced.
Urjit Patel, Governor, RBI (at the press briefing after the MPC meeting)
India Monetary Policy: MPC Hikes Rates For Second Straight Time

Not much by way of surprises, said R Sivakumar, head of fixed income at Axis MF, in reaction to the MPC decision. “The RBI is quite right to mark up their inflation forecasts for next year. They are looking at the minimum support prices announcement as a trigger for the rate increase. Other than that it's on track.”

But Sivakumar emphasised on why he thought that though the stated stance of the MPC is “neutral”, he didn’t think that told the full story.

I will reiterate that while the market reaction has been very muted, and the 10-year yield has barely budged, I still feel that two back-to-back rate hikes mean that the RBI is not in a neutral stance. And given the chance they will want to hike a couple of times more over the next few months.
R Sivakumar, Head - Fixed Income, Axis MF

Outlook On Growth

The MPC remains sanguine on growth and maintained its projection of 7.4 percent GDP for the current year. Growth is likely to range between 7.5-7.6 percent in H1 and 7.3-7.4 percent in H2, with risks evenly balanced, said the MPC.

The committee cited robust corporate earnings, a pick-up in investment activity, increased FDI flows and active capital raising as indictors that point to healthy economic activity.

"The MPC notes that domestic economic activity has continued to sustain momentum and the output gap has virtually closed. However, uncertainty around domestic inflation needs to be carefully monitored in the coming months," said the MPC.

The committee, however, took note of the rising global trade tensions and said this could pose to be a "grave risk to near-term and long-term global growth prospects."

The MPC notes that domestic economic activity has continued to sustain momentum and the output gap has virtually closed. However, uncertainty around domestic inflation needs to be carefully monitored in the coming months. In addition, recent global developments raise some concerns. Rising trade protectionism poses a grave risk to near-term and long-term global growth prospects by adversely impacting investment, disrupting global supply chains and hampering productivity. Geopolitical tensions and elevated oil prices continue to be the other sources of risk to global growth.   
Monetary Policy Committee Statement

Patel reiterated risks pertaining to the global economy in his media briefing and said India must be careful not to add to the global risk profile. “We are possibly at the beginning of currency wars. We must manage the risks that we can control. We have to run a tight ship.”

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