RBI governor says rate hike is primarily to maintain 4% inflation target

RBI Governor Urjit Patel, who heads the MPC, reiterated its intent to stick to the 4 percent inflation target in a press conference following the MPC's three-day deliberation on the interest rate decision.

"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.

Retail inflation had accelerated from 4.87 percent in May to 5 percent in June.

"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," Patel said.

RBI had to choose the timing of the rate hike between now and the October 2018 policy meeting.
A trigger to raise the interest rate sooner rather than later is the expectation of stronger inflationary pressures in the near future when the government starts procuring farmers’ crops at the higher prices it announced recently.

Hence, inflation projection for Q2 (July to September) was revised downwards at 4.6 percent and inched up to 4.8 percent (from 4.7 percent) in H2 of 2018-19. It also provided a forecast of 5 percent inflation for Q12019-20.

Hence, the rate hike was front loaded due to increased pricing pressures. 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 percent within a band of +/- 2 percent, while supporting growth."

Soumya Kanti Ghosh, Group Chief Economic Adviser at State Bank of India (SBI) said in a report, “Even as RBI decided to hike, RBI Governor later indicated in the press interaction that the Central Bank target is headline CPI and Core is only a component of it. It will be interesting to see how RBI will react to headline inflation which is expected to decline in coming months.”

Neutral stance – a break to further hikes?

All six members of the MPC, except Ravindra Dholakia voted in favour of a hike, while keeping the policy stance "neutral".

According to Patel, many of the risks cited by the MPC in its projections are on both sides.

“That’s why we have 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,” the RBI governor said.

“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,” Patel added.

An SBI report ruled out a rate hike in October and expects no further hikes in FY19.

Currency wars and protectionism

Post-policy, the Indian rupee closed at 68.43 against the dollar.

"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," the MPC warned in its policy statement.

Over the past few months, America and China have been engaged in a trade tussle, increasing duties on each other’s goods.

As a retaliation, China is speculated to be devaluing the yuan, which will affect other currencies, including the rupee. This artificial devaluation is used to make its goods and services cheaper than other countries.

But RBI chief warned that India must be careful not to add to the global risk profile.

“We have already had a few months of turbulence behind us and it looks like it is likely to continue. For how long, I don’t know. But the trade skirmishes have evolved into tariff wars and now 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,” Patel said.

While Asian currencies have been depreciating, the rupee has declined by 8 percent so far this year, making it one of the worst-performing currencies against the US dollar among its peers.

The rupee had hit a lifetime low of 69.12 on July 20.