Monetary Policy: RBI raises policy repo rate by 25 bps; keeps neutral stance

George Alexander Muthoot, MD - Muthoot Finance Limited on Second Bi-monthly Monetary Policy said,“We welcome the RBI`s decision to increase the repo rate by 25bps, first time since January, 2014. Given the inflationary pressure and rising food and fuel prices, this move looks positive for the economy. The rate hike gives a clear hint to India Inc to push for growth, take investment decisions as it can now foresee growth rate to pick up.”

The Reserve Bank of India's (RBI) Monetary Policy Committee (MPC), headed by Governor Urjit Patel said that for FY19, the forecast of a normal south-west monsoon augurs well for agriculture sector, as input cost pressures are firming up. He said cost of farm outputs has risen sequentially.
 
"Domestic economic activity has exhibited revival in recent times, he said, adding "farm loan waivers have been done through budgets of individual state governments, so there is no implications on banks' NPA." 
 
Urjit Patel also said that the monetary policy is determined by CPI. A neutral stance leaves all options open. Investment activity is estimated to be robust.

Highlights:

• RBI raises policy repo rate by 0.25% to 6.25%. The reverse repo rate now stands at 6.0%. Stance remains neutral.
• Inflation projection for H2 revised upwards. CPI inflation for 2018-19 revised to 4.8-4.9% in H1 from 4.7-5.1% earlier and 4.7% in H2 from 4.4% earlier.
• Upside risk to inflation path laid out in April have materialised in the form of sharp upward jump in crude prices (12%). The increase seems to be durable.
• Input price pressures are visible across different sectors and thus will lead to build-up in inflationary pressures.
• Impact of MSP formula for kharif crops is yet to be assessed.
• Growth is improving and output gap has almost closed. GDP growth retained at 7.4% for 2018-19.

Stocks from the rate-sensitive sectors such as realty, banking and auto gained in Wednesday's trade after Reserve Bank of India hiked interest rate by 25 basis points in its second bi-monthly monetary policy review of financial year 2019.  

Nifty Bank gained 0.4 per cent to 26,365.50. On the index, IDFC Bank, State Bank of India and Punjab National Bank added the most, rallying up to 6 per cent. HDFC Bank, ICICI Bank and Axis Bank shed up to 0.3 per cent.

The monetary policy committee lifted the repo rate by 25 basis points to 6.25 per cent, the first increase since January 2014.

All six members on the rate panel voted for an increase.

"I believe rate hike view of RBI is against the backdrop of market uncertainties, liquidity and imbalances in the bond market. While domestic macro factors are the primary concern for RBI, the global backdrop has become more important in recent months," said Mahesh Singhi, Founder & MD, Singhi Advisors

Watch Live: See how stocks are performing in midst of RBI monetary policy. 

The Sensex and Nifty extended gains after RBI hiked interest rate by 25 basis points as experts believe the move was already factored in, while Street cheered there was no change to neutral stance of the policy. 

At 3:00 pm, the Sensex was trading at 35,217, up 314.62 points, while the broader Nifty50 was ruling at 10,691, up 98.30 points.

Against the above backdrop, the MPC decided to increase the policy repo rate by 25 basis points and keep the stance neutral. The MPC reiterates its commitment to achieving the medium-term target for headline inflation of 4 per cent on a durable basis.

RBI says, liquidity remained generally in surplus during April - May. 

Liquidity in the system remained generally in surplus during April-May 2018. During April, the Reserve Bank absorbed surplus liquidity of Rs 496 billion on a daily net average basis due to increased government spending, especially in the second half of the month. Reflecting easy liquidity conditions, the weighted average call rate (WACR) softened to 5.89 per cent in April (from 5.96 per cent in March). However, surplus liquidity in the system moderated considerably in the first half of May and the system moved into deficit in the third week of May mainly due to inflows on account of the goods and services tax (GST). The Reserve Bank conducted an open market operation purchase auction on May 17, 2018 to inject liquidity of Rs 100 billion into the system. The system again turned into surplus in the last week of May reflecting mainly the payment of food subsidies. Surplus liquidity absorbed under the LAF on a daily net average basis declined to Rs 142 billion in May. The WACR in May at 5.88 per cent remained broadly at the April 2018 level.

For the purpose of computing LCR, it has been decided that, in addition to the above-mentioned assets, banks will be permitted to reckon as Level 1 HQLAs Government securities held by them upto another 2 per cent of their NDTL under FALLCR within the mandatory SLR requirement. Hence, the total carve-out from SLR available to banks would be 13 per cent of their NDTL. The other prescriptions in respect of LCR remain unchanged.

Turning to the growth outlook, the CSO’s provisional estimates have placed GDP growth for Q4:2017-18 at 7.7 per cent – 70 basis points higher than that in Q3 – given the sharp acceleration in investment and construction activity. With improving capacity utilisation and credit offtake, investment activity is expected to remain robust even as there has been some tightening of financing conditions in recent months. Global demand has also been buoyant, which should encourage exports and provide a further thrust to investment. The sharp rise in petroleum product prices, however, is likely to impact disposable incomes. Consumption, both rural and urban, remains healthy and is expected to strengthen further.

According to the early results of the Reserve Bank’s IOS, activity in the manufacturing sector is expected to moderate marginally in Q2:2018-19 on account of deterioration in the overall business situation and order book. On the basis of an overall assessment, GDP growth for 2018-19 is retained at 7.4 per cent as in the April policy. RBI has projected GDP growth in the range of 7.5-7.6 per cent in H1 and 7.3-7.4 per cent in H2, with risks evenly balanced

RBI says, "Actual inflation outcomes since the April policy have evolved broadly on the lines of the projected trajectory. However, there has been an important compositional shift. While the summer momentum in vegetable prices was weaker than the usual pattern, there was an abrupt acceleration in CPI inflation excluding food and fuel."

According to RBI, headline inflation outlook is driven primarily by two countervailing effects. On the one hand, CPI inflation excluding food and fuel rose sharply in April over March by 80 basis points to reach an ex-HRA level of 5.3 per cent, suggesting a hardening of underlying inflationary pressures. Furthermore, since the MPC’s meeting in early April, the price of Indian basket of crude surged from US$ 66 a barrel to US$ 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, as also confirmed in the Reserve Bank’s IOS for manufacturing firms in Q2:2018-19.

The resulting pick-up in the momentum of inflation excluding food, fuel and HRA has imparted persistence into higher CPI projections for 2018-19. On the other hand, food inflation has remained muted over the past few months and the usual seasonal pickup delayed, softening the projections in the short run. Taking these effects into account, projected CPI inflation for 2018-19 is revised to 4.8-4.9 per cent in H1 and 4.7 per cent in H2, including the HRA impact for central government employees, with risks tilted to the upside. Excluding the impact of HRA revisions, CPI inflation is projected at 4.6 per cent in H1 and 4.7 per cent in H2.

On the basis of an assessment of the current and evolving macroeconomic situation at its meeting today, the Monetary Policy Committee (MPC) decided to:

increase the policy repo rate under the liquidity adjustment facility (LAF) by 25 basis points to 6.25 per cent.

Consequently, the reverse repo rate under the LAF stands adjusted to 6.0 per cent, and the marginal standing facility (MSF) rate and the Bank Rate to 6.50 per cent.

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 per cent within a band of +/- 2 per cent, while supporting growth. 

RBI has raised CPI inflation target to 4.7% for six months up to March 2019. India’s Consumer Price Index (CPI) after relaxing for two consecutive months, once again inched upward to 4.58% in April 2018 compared to 4.28% in March, 4.44% in February, and is moving towards 5.07% mark recorded in January 2018. 

RBI in last policy revised it’s CPI inflation target to 4.7 - 5.1% in H1FY19 and 4.4% in H2FY19.