Except external member Ravindra Dholakia, the rest in the six-member monetary policy committee voted for a hike.
“We have to ensure that we run a tight ship and the risks that we control to maximise the chances of ensuring macroeconomic stability and continuing with a growth profile of 7 to 7.5 per cent,” RBI Governor Urjit Patel said in the policy press conference.
“We do have things that are in our favour and if we continue along that path we ensure that we do not add to the global risk profile that will adversely affect us,” the governor said.
The yields on the 10-year bond closed at 7.7 per cent, lower than its previous close of 7.8 per cent, whereas the rupee appreciated to close at a six week high of 68.43 a dollar, against its previous close of 68.55 a dollar.
Even as the RBI aims to keep consumer price-based inflation (CPI) anchored at 4 per cent (which is the middle point in the range 2-6 per cent), since November 2017 the CPI print has gone above that mark.
Publishing the inflation projection a year ahead for the first time, the central bank said it expected inflation to remain at 5 per cent in the first quarter of 2019-20.
In June this year, the CPI print came at 5 per cent too.
Since the transmission of monetary policy happens with a lag, the two rate hikes will take some time to work on inflation, said Viral Acharya, RBI deputy governor in charge of monetary policy.
The persistently high inflation level has clearly caused some nervousness in the minds of the MPC members. Patel acknowledged that as much in his post-policy conference.
“The main reason for changing the policy rate is to ensure that on a durable basis we come to and maintain the 5 per cent target, and we have been away from the 4 per cent number for several months now. We took two steps, once in June and once in August, to maximise our chances that we don’t drift from the target and so that we move towards the 4 per cent mark on a durable basis,” Patel said.
The RBI projected inflation at 4.6 per cent in the second quarter, and 4.8 per cent in the second half of the financial year 2018-19, with risks evenly balanced.
Excluding the HRA (house rent allowance) impact, CPI inflation is projected at 4.4 per cent in Q2, 4.7-4.8 per cent in H2 and 5 per cent in Q1, 2019-20.
According to Anubhuti Sahay, chief economist of Standard Chartered Bank, the RBI seeing inflation risks balanced was surprising because the central bank typically cautions risks being on the upside.
The recent increase in minimum support prices 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 bank said.
The RBI factored in some of the MSP-related impact, but the incremental impact remains to be seen, the central bank said, adding the staggered impact of HRA revision by state governments would push headline inflation up.
The balanced risk also has prompted the central bank to carry on with its neutral stance even after two rate hikes.
“There is a fair bit of uncertainty around the CPI prints and therefore it was important that we kept our options open, depending on the prints coming over the next few months, given the volatility of the prints that seem to be coming most of the time,” Patel said, adding the domestic inflation needed “careful monitoring”.
Even as the recent global trade war and the resultant currency devaluation “raise some concerns, the “domestic economic activity has continued to sustain momentum and the output gap has virtually closed”.
In the event of a currency war, the domestic currency gives in to depreciation pressure of the entire region. If the local currency depreciates, foreign investors are forced to liquidate their local holdings to minimise a currency hit. A rate hike by the central bank attempts to strengthen the currency by making the economy a better carry trade destination for foreign investors.
“The neutral stance accommodates upcoming domestic and external uncertainties, with regard to the impact of government’s policies, oil price direction, trade disputes and impact on global growth and US rate trajectory Until the December quarter, we expect the RBI to remain cautious, but on pause,” said Radhika Rao, India economist for DBS Bank.