RBI policy: 10 key takeaways from MPC’s rate hike

Shishir Kumar Asthana
Moneycontrol Research

Reserve Bank of India's (RBI’s) Monetary Policy Committee (MPC) obliged the market by giving what was expected from it -- a hike in repo rate by 25 basis points. On August 1, all members of the MPC, except Ravindra Dholakia, voted to hike the repo rate to 6.50% while keeping the policy stance unchanged at "neutral".

The bond market did not register the tremor, but the Bank Nifty showed some initial selling pressure. However, while the interest rate hike was a given as the central bank was behind the rate curve, it was always commentary that mattered.

Here are 10 key takeaways from the policy:

1. Rate hike to control inflation: The decision taken by MPC was to maintain the medium-term target for consumer price index (CPI) inflation of 4 percent within a band of +/- 2 percent without disturbing the growing economy.


2. Inflation outlook: The June round of the central bank’s survey of households reported a further uptick of 20 basis points in inflation expectations for both three-month and one-year ahead horizons as compared with the last round. Rising inflation outlook necessitated a higher interest rate. RBI governor in the post-policy conference pointed out that crude oil prices continue to be volatile and vulnerable to both upside and downside risk.


3. High cost seeps into the economy: Manufacturing firms polled by RBI reported higher input costs and selling prices in the first quarter of current fiscal. Farm and non-farm input costs rose significantly. Rural wage growth remained moderate while wage growth in the organised sector remained firm.


4. Retail inflation worrisome: Retail inflation, CPI rose from 4.9 percent in May to 5 percent in June, thanks to higher fuel prices, though food inflation remained muted. Adjusting for the estimated impact of the 7th central pay commission’s house rent allowances (HRA), headline inflation increased from 4.5 percent in May to 4.6 percent in June. CPI inflation is projected at 4.4 percent in the second quarter, 4.7-4.8 percent in second half and 5.0 percent in the first quarter of next fiscal.


5. Growth target maintained: Various data indicators in front of the MPC suggest that economic activity has continued to be strong. Monsoon and higher than expected MSP are expected to boost rural demand by raising farmers’ income. Investment activity remains firm while FDI flows have increased in the recent period. Activity in the manufacturing sector is expected to remain robust in the second quarter as per RBI. Based on these factors RBI has retained its growth forecast at 7.4 percent for 2018-19 is retained.


6. Export picks up: Exports, the second engine of growth has picked up in May and June 2018 with an across the board recovery. This is credible as the pickup is in the midst of a trade war that has enveloped the globe. Higher crude oil prices resulted in higher import growth but non-oil imports reduced.


7. Foreign fund outflow slows down: On the financing side, net foreign direct investment (FDI) flows improved significantly in the first two months of 2018-19. RBI points out that the tightening of liquidity conditions in advanced economies and growing protectionism has resulted in a slowing down of outflow. Higher FDI inflow in the first two months of the current fiscal helped the overall situation for the country.


8. A robust economy: The MPC reports points out that the economy is on a strong ground. Industrial growth, measured by the index of industrial production (IIP), strengthened in April-May 2018 on a y-o-y basis with all sectors of the economy participating in the growth. High-frequency indicators of services activity also increased at a faster pace. Tractor and two-wheeler sales growth accelerated significantly, suggesting strong rural demand.


9. MSP Impact: Government had recently increased the price at which it will purchase crop from farmers, which many had said will have a severe impact on the economy. RBI says that the move will have a direct impact on food inflation and second-round effects on headline inflation. RBI has already accounted for part of the increase in June policy and the remaining has been taken for in the present one. Though RBI remains cautious the action suggests that the MSP impact has been taken in RBI’s calculation in increasing the repo rates.


10. Trade War: The central bank is extra cautious over the ongoing trade war between the USA and rest of the world. RBI’s top official in the post-policy conference said that this is the start of the currency war and the central bank is keeping a close tab of it. 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. To add to that is the geopolitical tensions and elevated oil prices which can result in higher inflation.

Ironically, though the RBI has behaved on expected lines, it has increased interest rates twice while maintaining its ‘neutral’ stance. The market would surely run for cover when the stance changes to ‘bearish’.