The Reserve Bank of India’s monetary policy committee (MPC) on Wednesday
raised interest rates for the second straight meeting. The decision was widely expected — several polls, including one by CNBC-TV18, had predicted as much.
Inflation concerns was the primary factor that forced the MPC’s hand. The MPC has devoted much of its statement on why containing inflation was a priority.
The MPC noted that retail inflation, measured by the year-on-year change in the consumer price index, rose from 4.9 percent in May to 5 percent in June, driven by an uptick in inflation in fuel and in items other than food and fuel. Adjusting for the estimated impact of the Seventh Central Pay Commission’s house rent allowances (HRA), headline inflation increased from 4.5 percent in May to 4.6 per cent in June.
The good news was that food inflation remained muted due to lower than usual seasonal uptick in prices of fruits and vegetables in the summer months. Low inflation also continued in cereals, meat, milk, oil, spices and non-alcoholic beverages, and pulses and sugar prices remained in deflation.
The inflation outlook will be shaped by several factors, according to RBI. First the mitigating factors: the overall performance of the monsoon, moderating crude oil prices and the central government’s decision to reduce Goods and Services Tax (GST) rates on several goods and services all will have direct moderating impact on inflation.
But the central government has also decided to fix the minimum support prices (MSPs) of at least 150 percent of the cost of production for all
kharif crops for the sowing season of 2018-19. 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, RBI said. That apart, inflation in items excluding food and fuel has been broad-based and has risen significantly in recent months.
Several risks also persist on the inflation front, according to RBI. First, crude oil prices continue to be volatile and vulnerable to both upside and downside risks.
Second, volatility in global financial markets continues to impart uncertainty to the inflation outlook. Third, households’ inflation expectations, as measured by the Reserve Bank’s survey, have risen significantly in the last two rounds, which could influence actual inflation outcomes in the months to come. Fourth, manufacturing firms polled in the Reserve Bank’s industrial outlook survey have reported hardening of input price pressures in Q2 of 2018-19. Fifth, though the monsoon has been normal temporally so far, its regional distribution needs to be carefully monitored in the context of key CPI components such as paddy.
Sixth, in case there is fiscal slippage at the centre and/or state levels, it could have adverse implications for market volatility, crowd out private investment and impact the outlook for inflation. Seventh, uncertainty around the full impact of MSP on inflation will only resolve in the next several months once the price support schemes are implemented. Finally, the staggered impact of HRA revision by state governments may push headline inflation up.
Against this backdrop, the MPC said decided to increase the policy repo rate by 25 basis points. “The MPC reiterates its commitment to achieving the medium-term target for headline inflation of 4 per cent on a durable basis,” said a statement released on Wednesday.Read our full coverage on the
RBI Monetary Policy here.