RBI hikes repo rate by 25 bps to 6.50% for second time in a row

02 Aug 2018 Evaluate

In order to curb inflation and pre-empt a rout of the rupee as the global trade war escalates, the Reserve Bank of India (RBI), in its third bi-monthly monetary policy review of 2018-19, has hiked repo rate under the liquidity adjustment facility (LAF) by 25 basis points (bps) to 6.50%. Consequently, the reverse repo rate under the LAF stands adjusted to 6.25%, and the marginal standing facility (MSF) rate and the Bank Rate to 6.75%. This is the first time since October 2013 that the central bank has hiked borrowing costs at two consecutive policy meetings. The RBI has maintained a ‘neutral’ stance in the policy as it aimed to contain inflation while not chocking growth.

The central bank said that the MSP hike is the primary factor stoking inflation this year. The government has fixed MSP at 150% of the cost of production of all kharif crops. It added that this 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. It also highlighted its concerns over crude oil prices, which remain elevated, despite seeing a slight moderation. Considering these factors, the RBI has projected inflation at 4.6% in Q2, 4.8% in H2 of 2018-19 and 5.0% in Q1FY20, with risks evenly balanced. Excluding the HRA impact, CPI inflation is projected at 4.4% in Q2, 4.7-4.8% in H2 and 5.0% in Q1FY20.

On the economic front, the RBI retained the Gross Domestic Product (GDP) forecast for the current fiscal at 7.4% on robust corporate earnings and buoyant rural demand, though it flagged global trade tensions for Indian exports. It added that the growth would be in the range of 7.5-7.6% in first half of the fiscal and 7.3-7.4% in October-March 2018-19 period, with risks evenly balanced. The central has also projected the GDP growth for first quarter of the next financial year at 2019-20 at 7.5%. It further said that increased FDI flows in recent months and continued buoyant domestic capital market conditions bode well for investment activity. It also said that activity in the manufacturing sector is expected to remain robust in Q2, though there may be some moderation in pace.

However, the RBI Governor Urjit Patel warned global protectionism may snowball into a currency war and impact growth prospects. He said ‘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.’ He added that 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.

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