Urjit Patel, governor of the Reserve Bank of India (Photographer: Dhiraj Singh/Bloomberg)

India Kicks Off Gradual Rate Hike Cycle Amid Global Market Rout

(Bloomberg) -- India’s central bank raised its benchmark interest rate for the first time since 2014 and set the stage for a gradual tightening cycle as economic growth rebounds from a four-year low and price pressures build.

The six-member Monetary Policy Committee voted unanimously to increase the repurchase rate to 6.25 percent from 6 percent on Wednesday, as predicted by 14 of 44 economists in a Bloomberg survey. The Reserve Bank of India kept its policy stance neutral, which suggested the move was a “dovish hike,” according to economists at Nomura Holdings Inc.

Indian bonds slipped while the rupee advanced as the RBI joined peers in Indonesia, Turkey and Argentina in raising rates as policy tightening in the U.S. and a stronger dollar rattles broader emerging markets. Governor Urjit Patel recently called on the Federal Reserve to slow the pace at which it plans to shrink its balance sheet to help emerging economies cope with the turmoil.

The RBI cited volatile crude oil prices and global financial market developments as risks that will force policy makers to remain vigilant. Oil is India’s biggest import and rising prices are a threat not only to inflation, but also the nation’s sizable trade deficit, putting more pressure on the currency.

Consumer-price growth is already above the central bank’s 4 percent medium-term goal and with economic activity showing more signs of picking up, analysts say a rate hike, which reverses last August’s cut, shouldn’t choke off activity.

India Kicks Off Gradual Rate Hike Cycle Amid Global Market Rout

The forecast of normal monsoon rainfall is good for the farm sector, Patel said at a press conference in Mumbai. Capacity utilization has increased and a private survey shows factory activity is in expansionary mode in the past 10 months. Investment activity is expected to be robust despite tightening of financial conditions in recent months, he said.

Right Move

The RBI retained its GDP growth projection of 7.4 percent for the financial year to March 2019. It revised its inflation forecast to a range of 4.8 percent to 4.9 percent for the first half of the year from 4.7 percent to 5.1 percent, and raised the second-half estimate to 4.7 percent from 4.4 percent.

“Raising rates is a right move,” said N.R. Bhanumurthy, an economist at the Delhi-based National Institute for Public Finance and Policy. “Given the international conditions -- rising oil prices, the Fed’s rate policy and the fact that other emerging markets have already begun raising rates -- RBI should have probably raised rates earlier.”

What Our Economists Say...

The Reserve Bank of India’s surprise decision to raise rates signals strong intent to keep inflation in check in the face of the oil supply shock. It is likely to hurt the growth recovery, and turn out to be a one-and-done policy error, in our view. Inflation and growth are already poised to slow in coming months as base effects kick in.
-- Abhishek Gupta, Bloomberg Economics 

India has been swept up in an emerging market rout, with the rupee down 4.6 percent against the dollar this year, Asia’s worst performer. The central bank has stepped up efforts to support the rupee, draining foreign exchange reserves by $14 billion as part of its intervention plan.

“We believe that both growth and inflation are likely headed higher in the coming months,” Nomura economists Sonal Varma and Aurodeep Nandi said in a note, adding that paves the way for another 25 basis-point rate hike in August. But a pause thereafter is more likely as the ongoing tightening in financial conditions, higher oil prices and political uncertainty are likely to slow economic activity in September, they wrote.

Key points from the statement:

  • CPI projected at 4.7% in 2H including housing allowance to government staff
  • Major upside to inflation due to higher oil prices
  • GDP growth in 1H of fiscal 2019 seen at 7.5%-7.6% and 2H 7.3%-7.4%

The yield on 10-year government bonds climbed to a three-year high of 7.94 percent in May, while similar-maturity rates on top-rated corporate bonds surged to 8.70 percent Monday, the highest since November 2014. On Wednesday, the yield on the benchmark 10-year notes jumped eight basis points to 7.92 percent, while the rupee was 0.3 percent stronger.

Economic Affairs Secretary Subhash Chandra Garg said the rate hike removes uncertainty and should help steady markets. The policy statement was a “balanced assessment of growth, inflation and external situation and expectations,” he said in a Twitter post.

©2018 Bloomberg L.P.