Reserve Bank of India (RBI) Monetary Policy Review

A surprise for many as MPC hikes policy rate in over 4 years by 25bps to 6.25%


Published bi-monthly by the Reserve Bank of India (RBI). Updated to the month of June 2018. (Published on June 6th, 2018).

Recent Data Trend

In a move which many didn't foresee, the Monetary Policy Committee (MPC) under the RBI hiked the policy repo rate by 25bps to 6.25% in its second bi-monthly monetary policy statement. All the six members of the MPC voted unanimously for a rate hike. This marked the first rate hike by RBI in over four years. The decision came in different from the dominant market participants of a status quo on rates. (54% of respondents of Reuter's poll voted against a hike). The decision of MPC is fairly in line with our expectations as we had been in favour of a rate hike in the Jun'18 policy meeting.

With a hike in policy repo rate by 25 bps, consequently, the reverse repo rate under the liquidity adjustment facility (LAF) stood adjusted to 6% from 5.75%. The bank rate stood at 6.5%.

The policy statement reads that the decision for a rate hike is consistent with the neutral stance of monetary policy, in line with the objective of achieving the medium-term inflation target of 4%. The decision for a rate hike was taken due to building inflationary concerns and strong economic growth recovery in the last quarter of 2017-18, with real GDP soaring to a seven-quarter high growth of 7.7% YoY. The growth was investment-led shaving off concerns over muted investment in India.

On the inflation front, the retail inflation rose sharply to 4.6% YoY in Apr'16 driven by an increase in core inflation (inflation excl. food and fuel). Even inflation excluding the increase in the house rent allowances to central government employees rose to 4.2% in Apr'18 from 3.9% in Mar'18.

Further, the May 2018 round of household inflation expectations survey signals hardening of inflation in the near future as inflation expectations increased by 90bps for 3-month ahead and 130bps for one year ahead horizon. The industrial outlook survey (IOS) for the Sep-Dec'18 period also points to building input price pressures and increase in selling prices in the near future.

The recent rally in crude oil prices since the last MPC meet (from USD 66 per barrel in Apr'18 to USD 74 in Jun'18) also pushed up the inflation in the transport segment. All the above developments led RBI to revise its inflation projections upwards to 4.8-4.9% for Apr-Sep'18 and to 4.7% during Oct'18-Mar'19 from the earlier forecast of 4.4% for Oct'18- Mar'19. However, the RBI kept its growth projections unchanged at 7.4% for 2018-19.

We believe that price pressures are building up as reflected in the May round of household inflation expectation survey and industrial outlook survey. The RBI's task is likely to harden this year as the economy faces pressure from domestic as well as imported inflation.

Brief Overview
RBI's monetary policy has emerged as a critical policy tool for achieving overall macroeconomic management, price stability, and growth. The conduct of monetary policy has evolved over time on the front of the policy framework and operating procedure. Back in the 1980s, when the economy was plagued by high inflation fuelled by excessive money supply in the form of RBI credit to government, price stability became utmost important. So, RBI adopted "monetary targeting with feedback" (targeting money supply) as the monetary policy framework suggested by the Chakravarty Committee (1985).

With the development of the financial sector, liberalization of the economy (1991) and freeing up of interest rates and exchange rates, RBI shifted its focus from exclusive reliance on monetary aggregates to a broad set of indicators. Therefore, in 1998-99 RBI started pursuing the multiple indicators approach only to later face problems associated with fulfilling multiple objectives.

However, on the recommendations of Urjit Patel Committee (2014), RBI shifted to a new monetary policy framework of "inflation targeting". Since 2014-15, RBI has kept its mandate of achieving price stability and growth via inflation targeting.

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Next Release Date: August 1st, 2018