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Here's why Reserve Bank of India raised interest rates

Here's why Reserve Bank of India raised interest rates

Here's why Reserve Bank of India raised interest rates
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By Suman Singh  Jun 6, 2018 6:47:08 PM IST (Updated)

The Reserve Bank of India (RBI) on Wednesday raised the key rates, after four and a half years, by 25 basis points to 6.25%, in the June bi-monthly meet.

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The six-member MPC, including Urjit Patel, RBI governor, voted in favour of a rate hike.
The resolution of the Monetary Policy Committee (MPC) to hike key rates for the first time in over four years, comes due to inflation concerns, and risks associated with the Indian economy.
Here are the reasons which fueled the interest rate hike:
Global Front: 
  • Global economic activity has continued to expand, though there has been some easing of momentum. Among advanced economies, the US economy began the year on a weak note on soft private spending and reduced residential investment; however, there seems to be a rebound in the second quarter of 2018 with strong retail sales and improved employment data, since the last meeting in April.
  • The Euro area growth decelerated in the first quarter. Recent industrial production data as well as weak consumer and business sentiment suggest a loss of pace.
  • The Japanese economy contracted in the first quarter, though it is expected to turn around in Q2 as indicated by recent data prints on exports and the manufacturing purchasing managers’ index (PMI).
  • The Chinese economy maintained a strong momentum in the first quarter; more recent data on industrial production and PMI suggest that growth is likely to hold steady in the second quarter.
  • Economic activity in major emerging market economies (EMEs) remained largely resilient. In most EMEs, however, bond yields have risen on reduced foreign appetite for their debt due to growing dollar shortage in the global market and on prospects of higher interest rates in advanced economies. EME currencies have, by and large, depreciated against the US dollar.
  • Global trade growth has continued to strengthen, though geopolitical tensions have contributed recently to declining export orders and air freight.
  • Commodities and Foreign Exchange:
    • Crude oil prices rose sharply till May 24 on heightened geopolitical tensions, but moderated thereafter on expectations of easing of supplies by the Organisation of Petroleum Exporting Countries (OPEC) and Russia.
    • Gold has witnessed selling pressure on a stronger dollar, but the metal gained last week on political uncertainty in the Eurozone.
    • Inflation pressures have emerged in some key advanced and emerging economies, driven in part by rising commodity prices.
    • In currency markets, the US dollar touched its highest level in May since December 2017. The euro depreciated significantly against the dollar reflecting a combination of factors, including soft growth data for the Eurozone, which suggested that monetary policy normalisation by the European Central Bank could be delayed.
    • Equity Market:
      • Equity market performance has varied across regions with modest gains in advanced economies on strong first quarter earnings and abating of trade tensions, while stocks in major emerging  have faced sell offs on a rising dollar and expectations of further rate hikes by the US Federal Reserve.
      • The 10- year sovereign yield in the US crossed 3% in mid-May on strong economic data as well as expectations of tighter monetary policy and fiscal expansion, but softened subsequently on safe haven demand; yields softened in other key advanced economies as well.
      • Domestic Front:
        • Gross domestic product (GDP) growth for 2017-18 has been estimated at 6.7%, up by 0.1 percentage point from the second advance estimates released on February 28. This increase in growth has been underpinned by a significant upward revision in private final consumption expenditure (PFCE) due especially to improved rural demand on the back of a bumper harvest and the government’s thrust on rural housing and infrastructure.
        • Quarterly data suggest that the economy grew at 7.7% in Q4:2017-18 – the fastest pace in the last seven quarters. Gross fixed capital formation (GFCF) growth accelerated for three consecutive quarters up to Q4.
        • On the supply side, estimates of agriculture and allied activities have been revised upwards, supported by an all-time high production of foodgrains and horticulture during the year. On a quarterly basis, agriculture growth increased sharply in Q4:2017-18.
        • On April 16, the India Meteorological Department (IMD) forecast a normal south-west monsoon rainfall, which was reaffirmed on May 30. This augurs well for the agricultural sector.
        • Industrial growth also strengthened, reflecting the robust performance of manufacturing, which accelerated for three consecutive quarters in Q4. However, electricity generation slowed down. As per the early results of the Reserve Bank’s April-June round of the industrial outlook survey (IOS), activity is expected to expand at a lower rate in Q1:2018-19 due to a significant rise in input prices and perceptions of softening domestic and external demand conditions.
        • The manufacturing PMI remained in an expansionary mode for the tenth consecutive month in May on the back of new domestic orders and exports.
        • Although services sector growth was revised downwards on account of lower growth in some constituents such as trade, hotels, transport & communication, and financial services, it remained robust.
        • Improving sales of tractors and two-wheelers suggest strengthening of rural demand. Commercial vehicle sales also accelerated in April. Revenue-earning freight traffic of railways picked up, driven by improved movement in coal, fertilisers, and cement. Growth in passenger vehicle sales accelerated but port traffic decelerated for the third successive month in April. Domestic air passenger traffic rose significantly in April. Two key indicators of construction activity showed improvement – cement production growth accelerated and steel consumption turned around. Services PMI moved slightly into contraction in May, reflecting decline in business activity and stagnation in new orders.
        • Retail inflation, measured by the year-on-year change in the CPI, rose sharply to 4.6% in April, driven mainly by a significant increase in inflation excluding food and fuel.
        • Food inflation moderated for the fourth successive month, pulled down by vegetables due to lower than the usual seasonal increase in their prices, and pulses and sugar which continued to experience deflation.
        • Fuel group inflation declined for the fifth month in a row in April mainly on account of a fall in the inflation of liquefied petroleum gas in line with international prices, and electricity. However, inflation in other major items of fuel such as firewood and chips, dung cake, kerosene and coal inched up.
        • Inflation in the transport and communication sub-group accelerated due to the firming up of international crude oil prices, even though the domestic pass-through to petrol and diesel was incomplete.
        • Inflation in the transport and communication sub-group accelerated due to the firming up of international crude oil prices, even though the domestic pass-through to petrol and diesel was incomplete.
        • Surplus liquidity absorbed under the LAF on a daily net average basis declined to Rs 142 billion in May. The WACR in May at 5.88% remained broadly at the April 2018 level.
        • India’s exports grew in April 2018 after a marginal dip in the preceding month, supported mainly by non-oil exports, particularly engineering goods and chemicals. Import growth decelerated sequentially in April 2018; a significant decline in imports of gold as well as pearl and precious stones more than offset the impact of rising crude oil prices. Nevertheless, the trade deficit expanded in March and April from its level a year ago.
        • While net foreign direct investment in 2017-18 was broadly comparable with the previous year, net foreign portfolio flows were stronger due to a sharp turnaround in debt inflows. However, foreign portfolio investors withdrew $ 6.7 billion on a net basis from the domestic capital market in 2018-19 (up to June 4) reflecting volatility in global financial markets. India’s foreign exchange reserves were at $412 billion on June 1, 2018.Read our extensive coverage of the RBI policy meet here.
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