RBI Monetary Policy: Patel hikes rate by 25 bps for second time; policy repo rate at 6.50%

RBI monetary policy 2018: The Reserve Bank of India made 25 basis point hike in the policy repo rate to 6.50% compared to the previous 6.25%. This is the second rate hike by RBI, as in the previous policy, the central bank, under leadership of Governor Urjit Patel made its first hike (of 25 basis points) for the first under the Prime Minister Narendra Modi led NDA government tenure. Consequently, the reverse repo rate under the LAF stands adjusted to 6.25%, and the marginal standing facility (MSF) rate and the Bank Rate to 6.75%.

The decision of the MPC is consistent with the neutral stance of monetary policy in consonance with the objective of achieving the medium-term target for consumer price index (CPI) inflation of 4% within a band of +/- 2%, while supporting growth.

In the second bi-monthly resolution of 2018-19, CPI inflation for 2018-19 was projected at 4.8-4.9% in H1 and 4.7% in H2, including the HRA impact for central government employees, with risks tilted to the upside. Excluding the impact of HRA revisions, CPI inflation was projected at 4.6% in H1 and 4.7% in H2.

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Actual inflation outcomes have been slightly below the projected trajectory as the seasonal summer surge in vegetable prices has remained somewhat muted in comparison with its past behaviour and fruits prices have declined. 

The inflation outlook is likely to be shaped by several factors as per RBI.

First, the central government has decided to fix the minimum support prices (MSPs) of at least 150% 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. 

Secondly, the overall performance of the monsoon so far augurs well. Also, crude oil prices have moderated slightly, but remain at elevated levels. 

Further, the central government has reduced Goods and Services Tax (GST) rates on several goods and services. This will have some direct moderating impact on inflation, provided there is a pass-through of reduced GST rates to retail consumers for food inflation in the medium-term. 

Based on an assessment of the above-mentioned factors, inflation is projected at 4.6% in Q2, 4.8% in H2 of 2018-19 and 5.0% in Q1:2019-20, with risks evenly balanced. 

Excluding the HRA impact, CPI inflation is projected at 4.4% in Q2, 4.7-4.8% in H2 and 5.0% in Q1:2019-20.