Repo rate hike by RBI indicates acceptance of inflationary trend

Rohit Chandavarkar
Thursday, 7 June 2018

The two economic challenges that the government currently faces are inflation and lack of job creation. The current trend of inflation is ironically ‘fuelled by’ the petrol diesel price hike! India has seen close to 110 per cent hike in excise duty on fuel. This has now resulted in prices of fuel crossing record high levels. 

The two economic challenges that the government currently faces are inflation and lack of job creation. The current trend of inflation is ironically ‘fuelled by’ the petrol diesel price hike! India has seen close to 110 per cent hike in excise duty on fuel. This has now resulted in prices of fuel crossing record high levels. 

This as expected has had a cascading effect on consumer good and commodity prices. The repo rate revision by the Reserve Bank of India (RBI) coming after four years is nothing but an acceptance by the central bank of the country that an inflationary trend is there to stay.  

The monetary policy committee or MPC announced this rate hike on Wednesday. This was somewhat unexpected. RBI Governor Urjit Patel said, “The MPC felt there was enough uncertainty to stick to the neutral stance and yet respond to the risks to inflation target that have emerged in the recent months.” 

The MPC’s decision to hike policy rates comes against the backdrop of rising inflation, higher oil prices and a weaker currency.

The committee expects retail inflation at 4.8-4.9 per cent in the first half of the year and at 4.7 per cent in the second half of the year. Retail inflation, which the MPC targets, stood at 4.58 per cent in April. Core inflation rose to a near four-year high of 6 per cent. 

The MPC is targeting to maintain inflation in a band of 4 (+/- 2) per cent. Since the last policy review, oil prices have risen by close to 12 per cent and the rupee has depreciated nearly 3 per cent. A major upside risk to inflation has materialised due to higher oil prices, noted the MPC. It added that there has been a ‘significant rise’ in household inflation expectations which could feed into wages and input costs. 

Meanwhile, growth has recovered along expected lines even though it remains supported by government spending. GDP growth rose to 7.7 per cent in the fourth quarter of financial year 2017-18 compared to 7 per cent in the third quarter. 

The MPC sees GDP growth at 7.4 per cent in FY19. Investment activity is recovering well and could receive a further boost from resolution of stressed assets, the MPC noted.

As reported by a leading economic news website, Indian sovereign bonds slipped and the rupee advanced after the policy announcement. The yield on the benchmark 10-year bonds jumped to as high as 7.92 per cent, before paring its advance to 7.89 percent. The rupee swung between gains and losses before trading 0.1 per cent higher at 67.07 per dollar.

When asked whether the central bank will use interest rates to defend the currency, the RBI governor said that domestic monetary policy will be dictated by the inflation framework. The RBI allowed banks to spread April-June mark-to-market losses over four quarters, starting from three months ended June 2018.

The circular in this regard will be issued within a week, the RBI said. 
“It has been decided to grant banks the option to spread the mark-to-market (MTM) losses on investments held in Available for Sale (AFS) and Held for Trading (HFT) portfolio for the quarter ending June 30, 2018, equally over a period of four quarters, commencing from the quarter ending June 30, 2018,” said the RBI’s statement on developmental and regulatory policies.

This means the consumers will have to pay higher for their home loans or other loans and generally, inflation will continue.  How to offset this by creating job opportunities and achieving higher growth is the challenge the government has to now meet.

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