For the second time in as many months, RBI today raised the key interest rate by 0.25 per cent to the highest level in two years as it battled inflation without looking to harm growth, but the move may result in costlier home, auto and other loans.
With five out of the six members voting for the increase, the Monetary Policy Committee (MPC) headed by RBI Governor Urjit Patel increased repo rate, at which it lends to other banks, to 6.5 per cent from 6.25 per cent currently but kept its policy stance as "neutral".
In June, the MPC had raised the key rate by a similar 25 basis points or 0.25 per cent.
It was widely expected that Reserve Bank of India will wait for the full impact of increase in minimum support price (MSP) for kharif foodgrains, the monsoon progress and the US Fed outcome before hiking rates in October. However it chose to pre-empt inflation by hiking the rates by another 25 basis points ahead of the inflation risks actually manifesting itself.
RBI expects the inflation rate to gradually go up to 5 per cent by the first half of 2019-20, which will be an election year.
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The reverse repo rate, at which it borrows from banks, was also raised by similar proportion to 6.25 per cent.
The marginal standing facility (MSF) rate and the Bank Rate were raised to 6.75 per cent. The RBI chose not to tinker with the CRR or with the SLR, which are currently steady at 4 per cent and at 19.5 per cent respectively.
After delivering the first back-to-back rate increase since it was set up in September 2016, the MPC warned 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."
It saw geopolitical tensions and elevated oil prices to be sources of risk to global growth.
Patel too gave a warning. "We have already had a few months of turbulence behind us and it looks like that this is likely to continue. For how long, I don't know. The trade skirmishes evolved into tariff wars and now we are possibly at the beginning of currency wars."
The rupee is Asia's worst-performing major currency this year, down almost 7 per cent against the dollar.
"Given this, we have to ensure that we run a tight ship on the risks that we control to maximise the chances of ensuring macro-economic stability and continuing with the growth profile of 7-7.5 per per cent," he said.
Commenting on the move, the government said the impact of MSP hike on inflation will gradually taper. "The effect of hike in MSP will play out gradually over a period of time. So it appears to us that this is not a serious risk to inflation," Economic Affairs Secretary S C Garg said here.
Fiscal impact would come towards the end of this fiscal, he added.
As per the RBI's policy document, 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 central government has decided to fix the MSPs of at least 150 per cent of the cost of production for all kharif crops for the sowing season of 2018-19.
"A part of the increase in MSPs based on historical trends was already included in the June baseline projections. As such, only the incremental increase in MSPs over the average increase in the past will impact inflation projections," it said.
On RBI monetary policy action, Garg said it speaks about growth remaining unchanged.
"It also speaks of inflation, essentially saying that Q1 inflation has been lesser than the last projection. On inflation RBI's assessment is almost unchanged or slightly better. In the light of these factors growth seems to be unchanged," he said.
While inflation projection for the second half of 2018-19 fiscal year was raised to 4.8 per cent from 4.7 per cent, FY19 growth projection was retained at 7.4 per cent.
Following the rate hike, the BSE index Sensex slipped from record high to ends 84.96 points lower at 37,521.62.
Anticipating firming of interest rate, country's largest lender SBI has raised fixed deposit rate by up to 0.1 per cent. Other banks are also likely to firm up lending rates making loans costlier for borrowers.
RBI had last raised the repo rate on June 6 by 0.25 per cent to 6.25 per cent. That increase was the first since January 28, 2014 when rates were hiked by a similar proportion to 8 per cent.
In the subsequent years, RBI cut interest rate on six occasions. In its last revision, on August 2, 2017, rates were cut by 25 basis points to 6 per cent.
In the third bi-monthly monetary policy of the 2018-19, RBI today cited various concerns to inflation like volatile crude prices, uncertainty in the global financial market, hardening of input prices for corporates, uneven distribution of rainfall, fiscal slippages and rise in MSP of foodgrains.
The next meeting of the MPC is scheduled from October 3 to 5, 2018.
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