After a prolonged pause, the six-member Monetary Policy Committee of the Reserve Bank of India voted unanimously in favour of a 25-basis points hike in the policy repo rate to 6.25 per cent even as it kept the monetary policy stance neutral.

The last rate action was in August 2017, when the MPC cut the repo rate — the interest rate at which banks borrow funds from the central bank to overcome short-term liquidity mismatches — from 6.25 per cent to 6 per cent. The hike on Wednesday is the first in four years.

Crude impact

Seen as a pre-emptive move by market participants to rein in inflation, the rate increase comes in the backdrop of rising inflationary pressures arising from volatile crude oil prices, increase in other global commodity prices and recent global financial market developments. However, the RBI has kept its policy stance neutral.

The repo rate hike may prompt banks to further raise their deposit and lending rates. In the past couple of weeks, State Bank of India, Punjab National Bank, Bank of Baroda and ICICI Bank increased their deposit and lending rates.

Asked if the rate hike and the neutral policy stance were contradictory, RBI Governor Urjit Patel said: “A neutral stance leaves all options open. The committee felt that there was enough uncertainty for us to keep to the neutral stance and yet respond to the risk to the inflation target that has emerged in recent months.”

The Governor underscored that in May, households reported a significant rise in inflation expectations. Manufacturing firms reported input price pressures and increase in selling prices. The cost of farm inputs and raw material costs have risen sequentially.

“Since the MPC’s meeting in April, the price of the Indian basket of crude surged from $66 a barrel to $74. This, along with an increase in other global commodity prices and recent global financial market developments, has resulted in a firming up of input cost pressures and persistence in the higher CPI (consumer price index) projections for 2018-19,” explained Patel.

Madan Sabnavis, Chief Economist CARE Ratings, said: “Going ahead, inflation will be guided by the progress and spread of the monsoon. We expect one more interest rate hike of at least 25 basis points this year, and in fact cannot rule out the possibility of two rate hikes by the end of FY 2018-19, which will depend on the developments at the global front with regard to oil prices and its likely impact on domestic inflation.”

Inflation projection revised

The RBI revised the projected CPI inflation for 2018-19 to 4.8-4.9 per cent in the April-September (H1) period against the earlier projection of 4.7-5.1 per cent. The projection for the October-March (H2) period has been upped to 4.7 per cent from 4.4 per cent earlier.

The MPC said it is important that public finances (borrowings by Central and State governments) do not crowd out private sector investment activity at this crucial juncture. Adherence to budgetary targets by the Centre and the States – which appears to be the case thus far – will also ease upside risks to the inflation outlook considerably.

The GDP growth for 2018-19 has been retained at 7.4 per cent as in the April policy.

Welcoming the monetary policy stance, Economic Affairs Secretary Subhash Chnadra Garg said he believed that the current assessment did strike a balance among growth, inflation and external situation and expectations.

Railways Minister Piyush Goyal tweeted to claim that the RBI action policy “confirms that economic activity is on the upswing.”

Markets gain

The Sensex and the Nifty gained close to 1 per cent as traders took a cue that the rupee may not weaken sharply further. The Sensex rose 275 points or 0.8 per cent to close at 35,178. The Nifty rose 91 points or 0.86 per cent to close at 10,684. After five consecutive days of falls, the BSE MidCap and SmallCap indices gained 1.28 per cent and 1.53 per cent, respectively.