The hike comes at a time when retail inflation has accelerated from 4.87 percent in May to 5.0 percent in June
The Reserve Bank of India (RBI) on Wednesday raised its key lending rate — the repo rate — by 25 basis points to 6.5 percent, keeping its focus firmly on taming inflation, but sounded bullish about the broader economy’s prospects that was readying to move into faster lane.
The six-member monetary policy committee (MPC), headed by RBI governor Urjit Patel, was of the view that inflation was rising fast enough to warrant a hike in interest rates to cool off price rise.
That said, there were signs that the real economy has decisively gathered speed, leaving behind the disruptions caused by the twin policy shocks of demonetisation and the goods and services tax (GST).
It, however, retained the gross domestic product (GDP) growth projection for 2018-19 at 7.4 percent, ranging 7.5-7.6 percent in April-September and 7.3-7.4 percent in October-March, with risks evenly balanced. It projected GDP to grow at 7.5 percent in April-June next year.
The central bank also revised its inflation projections, primarily driven by higher support prices for summer crops.
Inflation is now projected at 4.6 percent in July-September, 4.8 percent in October-March (2018-19) and 5 percent in April-June 2019, with risks evenly balanced.
“Various indicators suggest that economic activity has continued to be strong. Robust corporate earnings, especially of fast moving consumer goods (FMCG) companies, also reflect buoyant rural demand,” the RBI said in its monetary policy statement.
Investment activity remains firm even as there has been some tightening of financing conditions in the recent period. Increased FDI flows in recent months and continued buoyant domestic capital market conditions bode well for investment activity, it said.
The RBI’s investment outlook survey (IOS) indicates that activity in the manufacturing sector is expected to remain robust in July-September, though there may be some moderation in pace.
Household spending is on the rise as can be gauged from standard proxies such as car and consumer good sales.
Manufacturing activity has also shown strong revival signs. The Nikkei India purchasing managers’ index (PMI) for manufacturing — an indicator of industrial activity —posted 52.3 in July, down from 53.1 in June. Although modest, the latest improvement in the health of the manufacturing sector was the second-strongest (behind June) since January.
Indian manufacturing output rose in July, thereby stretching the period of expansion to 12 months. Despite easing from June’s six-month high, the latest upturn was marked and stronger than the current sequence of growth.
Inflation rates have been rising sharply over the last few months. Consumer price index (CPI)—commonly referred to as retail inflation that the RBI tracks—has risen to 5 percent in June. It has remained higher than the RBI’s target of 4 percent for eight consecutive months.
While inflation in June was mainly driven by non-food segments, food inflation could rise on the back on higher support prices that the government has announced.
The government has announced a sharp rise in minimum support prices (MSPs) for 14 summer-sown kharif crops. MSP is the price at which the government buys crops from farmers, and acts as a kind of guaranteed floor price, aimed to prevent distress sale by farmers.
The government has set the MSP at a minimum of 1.5 times the cost of cultivation, a proposal made in the budget for 2018-19. This is the biggest increase in the Narendra Modi government’s tenure.
The RBI and the government has set a retail inflation target of 4 percent for next five years with an upper tolerance level of 6 percent and lower limit of 2 percent.
Non-food, non-fuel inflation or economists refer to as `core inflation’ touched a four year high of 6.4 percent in June, but could down in the coming months GST Council decided to slash rates on a host of items such as televisions, refrigerators, washing machines, and electrical appliances among others.
“The 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,” the RBI said.
The reduction in GST rates, the RBI said, will have some direct moderating impact on inflation, provided there is a pass-through of reduced GST rates to retail consumers.
The central bank said that “uncertainty around domestic inflation needs to be carefully monitored in the coming months”.
In addition, recent geopolitical tensions, rising protectionism and elevated oil prices continue to be the other sources of risk to global growth.In the MPC, Chetan Ghate, Pami Dua, Michael Debabrata Patra, Viral V. Acharya and Urjit R. Patel voted in favour of the decision, while Ravindra H Dholakia voted against the decision.