Interest rates on an upward trajectory from here on

Inflationary expectations, global uncertainties and minimum support price (MSP) weighed on the monetary policy committees (MPC) rate decision on Wednesday.

The MPC against popular market expectation hiked key policy rate—repo rate by 25 basis points to 6.50 percent. A tough call has been taken to maintain a balance between growth and inflation.

The MPC’s tough decision today is to calibrate the quantum of rate hikes in future. This is the first time in five years, the central bank has hiked borrowing costs at two consecutive policy meetings.

Urijit Patel-led Reserve Bank of India’s stance is an indication to the market that further rate actions by the central bank would be data dependent.

Core inflation remains a main concern for the central bank. Core inflation, excluding food and fuel, is likely to stay above the RBI targeted inflation rate of 4 percent.

RBI also raised its average inflation projection for the second half of the year to 4.8 percent from the 4.7 percent it had projected in June. The central bank expects inflation to edge higher to 5 percent in the first quarter of the next fiscal year.

Global uncertainties and rise in global crude oil prices pose a grave risk to inflationary expectations.

Global crude oil prices have surged nearly 20 percent this year and crossed $80 a barrel in May, their highest since 2014.

Though it is currently, hovering above $70 a barrel it is a threat to the fiscal health and inflationary expectations. Fuel is the biggest item on India’s import bill and with Rupee testing new life lows inflationary threats looms large. These have influenced the decision of the MPC.

In an election year anticipation of higher government spending and its impact on inflation will continue to dominate the RBI view on interest rates.

The hike in interest rates would impact lending and deposit rates. Home loans, auto loans and personal loans will now get costlier as lending institutions may not be able to absorb the costs. Depositors have reason to rejoice as interest rates on deposits will increase. Many lenders both private and public have already increased their fixed deposits and lending rates in anticipation of an RBI rate hike. This is a clear indication that interest rates are on a rising trajectory.

Despite the rise in interest rate, the growth momentum is expected to remain robust. The central bank has maintained the GDP growth projection for 2018-19 as in the June statement, at 7.4 percent, ranging 7.5-7.6 percent in H1 and 7.3-7.4 percent in H2, with risks evenly balanced; GDP growth for Q1:2019-20 is projected at 7.5 percent.

The rural economies are seeing good recovery due to a healthy monsoon. Auto sales numbers are encouraging. Tractor and two-wheeler sales growth accelerated significantly, suggesting strong rural demand. Passenger vehicle sales growth, an indicator of urban demand have also strengthened. Commercial vehicle sales growth also remains robust.

Despite the uncertain global environment, domestic demand drivers will support India’s growth story.