Monetary Policy: MPC Hikes Interest Rates For The First Time In Over Four Years  

India’s monetary policy committee voted unanimously to increase the benchmark repo rate for the first time in more than four years, as it tries to fend off rising inflation pressures.

The repo rate was raised by 25 basis points to 6.25 percent. The last time this benchmark rate was raised was in January 2014. The reverse repo rate stands increased to 6 percent from 5.75 percent. Fourteen of 43 economists polled by Bloomberg had forecast a 25 basis point hike in rates.

Post the rate hike, the MPC maintained its monetary policy stance at ‘neutral’, giving it the flexibility to move in either direction. “The decision of the MPC 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 percent within a band of +/- 2 percent, while supporting growth,” the committee said in its statement.

A neutral stance leaves all options open, Reserve Bank of India Governor Urjit Patel said in the press briefing to announce the policy. “The MPC felt there was enough uncertainty to stick to neutral stance and yet respond to the risks to inflation target that have emerged in the recent months.”

The MPC’s decision to hike policy rates comes against the backdrop of rising inflation, higher oil prices and a weaker currency.

The committee expects retail inflation at 4.8-4.9 percent in the first half of the year and at 4.7 percent in the second half of the year.

Retail inflation, which the MPC targets, stood at 4.58 percent in April. Core inflation rose to a near four-year high of 6 percent. The MPC is targeting to maintain inflation in a band of 4 (+/- 2) percent. Since the last policy review, oil prices have risen by close to 12 percent and the rupee has depreciated nearly 3 percent.

A major upside risk to inflation has materialized due to higher oil prices, noted the MPC. It added that there has been a “significant rise” in household inflation expectations which could feed into wages and input costs.

Meanwhile, growth has recovered along expected lines even though it remains supported by government spending. GDP growth rose to 7.7 percent in the fourth quarter of the financial year 2017-18 compared to 7 percent in the third quarter. The MPC sees GDP growth at 7.4 percent in FY19. Investment activity is recovering well and could receive a further boost from resolution of stressed assets, the MPC noted.

Indian sovereign bonds slipped and the rupee advanced after the policy announcement. The yield on the benchmark 10-year bonds jumped to as high as 7.92 percent, before paring its advance to 7.89 percent. The rupee swung between gains and losses before trading 0.1 percent higher at 67.07 per dollar.

When asked whether the central bank will use interest rates to defend the currency, the RBI governor said that domestic monetary policy will be dictated by the inflation framework.

Outlook For Rates

The hike in interest rates signalled 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

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.

One More Hike In Store In FY19: India Ratings

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, JPMorgan

Sajjid Chinoy of JPMorgan agreed that more hikes may be in store this year, possibly in October.

“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,” the chief India economist at JPMorgan told BloombergQuint in an interview.

If global oil prices were to stabilise at current levels, another 25 basis point hike in the repo rate would be sufficient, he added.

RBI Stance On Liquidity & Bonds

The RBI also reiterated its stance that its liquidity operations would be guided by systemic requirements and not by price moves for long term assets like bonds.

Injections of durable liquidity will be guided by the need to maintain overnight call money market rates at close to the policy repo rate, Patel said during the press conference. Deputy Governor Viral Acharya also highlighted that liquidity has remained close to neutral over the past few months.

The clamor for bond purchases under the RBI’s open market operation program has risen due to the rise in the benchmark 10-year bond yield.

While the RBI has not eased its stance on liquidity, it has given banks more room to spread the mark to market losses on their bond portfolios.

Banks can spread the April-June mark-to-market losses over four quarters, starting from three months ended June 2018, the RBI said.

“It has been decided to grant banks the option to spread the mark-to-market (MTM) losses on investments held in Available for Sale (AFS) and Held for Trading (HFT) portfolio for the quarter ending June 30, 2018, equally over a period of four quarters, commencing from the quarter ending June 30, 2018,” said the RBI’s statement on developmental and regulatory policies.