RBI hikes repo rate by 25 basis points to 6.25%

Daniel Fowler
June 7, 2018

Prompted by inflation fears and emboldened by growth, Urjit Patel on Wednesday delivered his first rate hike since taking over as Reserve Bank of India (RBI) governor in September 2016.

"With growth strengthening and core inflation picking up, we think today's hike marks the start of a modest tightening cycle", said Shilan Shah, the senior India economist at Capital Economics.

While economic growth makes every government happy, it dreads sharp price rises, especially ahead of elections.

Nonetheless, the biggest driver for the hike in the interest rate is rising inflation in the country.

The RBI's monetary policy committee lifted the repo rate by 25 basis points to 6.25 percent.

If the repo rate is low then banks can charge lower interest rates on the loans taken by us. All the members of RBI's MPC voted in favour of a rate hike. Expectation is that the central bank could hold rates but at the same time could change its stance from "Neutral" to "Hawkish", said motilal Oswal.

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Under the MPC mechanism, the RBI is required to ensure that retail inflation stays between 2% to 4%, with extra flexibility of 2% on either side. This is the first rate hike by the MPC in almost four-and-a-half years. While growth is strengthening, the services industry, which contributes about 55 percent to gross domestic product, probably contracted in May for the first time in three months, according to the services purchasing managers index. "Investment activity, in particular, is recovering well and could receive a further boost from swift resolution of distressed sectors of the economy under the Insolvency and Bankruptcy Code", the monetary policy statement said.

But last week India said its GDP for the first quarter expanded by 7.7 per cent - the highest in two years. Consumer price inflation or CPI was 4.6 per cent in April 2018.

The bank cited a recent spike in oil prices as one of the main factors in its decision. The rupee has also come under pressure with the United States dollar gaining against most emerging market currencies. In its Second Bi-monthly Monetary Policy Statement, the central bank has marginally revised upwards its inflation projection for the current fiscal on firming crude oil prices in the global market. Also, medium and small enterprises have been given some relief in loan repayment.

It simply means repo rate is the rate at which RBI lends money to commercial banks against the pledge of government securities whenever the banks are in need of funds to meet their day-to-day obligations. With the fresh 25 bps hike, the reverse repo rate has now gone up to 6 per cent.

Increasing crude oil prices and a weakening rupee have added to the inflationary trends.

Dwelling on the risks posed by the strength in the global crude oil market, the MPC said, "Crude oil prices have been volatile recently and this imparts considerable uncertainty to the inflation outlook - both on the upside and the downside". He said the pace of inflation would depend on the progress and spread of monsoon.

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