India: Reserve Bank hikes rates for second time

In its second policy tightening this year, the RBI lifted the benchmark policy interest rates by 25 basis points today, taking the repo rate to 6.50% and reverse repo rate to 6.25%. There was no change to the 4% reserve requirement rate for the banking sector.

However, unlike the June rate hike, today’s decision wasn’t a unanimous vote by all six policy committee members. There was one dissenter. Still, the outcome was in line with the broad consensus, including ING's forecast. Hence, we expect little to no market impact.

• Inflation: The RBI raised its inflation forecast for the second half of FY2018-19 (financial year runs from April to March) to 4.8% from 4.7%. Although a slight rise, the statement notes that a larger than average increase in minimum support prices (MSP) for farmers will have a direct impact on food inflation and then to headline inflation. Further, inflation in items excluding food and fuel has been broad-based and has risen significantly in recent months, reflecting greater pass-through of rising input costs and improving demand conditions.
• Some relief is likely from good monsoon support to the farm sector and a reduction in Goods and Services Tax for several goods and services. But the upside inflation risks outweigh the downside risks due to supply disruptions to oil prices and elevated household inflation expectations.
• Growth: There was no change to the RBI’s GDP growth forecast for FY2019 from its 7.4% projection in the June policy statement. The statement points to evenly balanced growth risks, with good monsoon support to farm output and MSP prices contributing to improved rural demand. It also said good corporate earnings and FDI inflows would support investment. On the downside, rising trade tensions could adversely impact exports.

The minutes of today’s meeting to be released later this month will provide more insight into policymakers’ thinking. While we believe the current tightening cycle has further room to run, the extent of tightening will depend on how India’s growth-inflation dynamics evolve going forward.

We have already seen some signs of tapering in GDP growth starting from the April-June quarter. Although exports gained some traction in May and June, this hasn’t stimulated manufacturing enough to push GDP growth higher while a wider trade deficit has meant a larger negative contribution of net exports to GDP growth. Higher global trade tariffs will be the potential dampener on exports and GDP growth going forward. This is why we recently cut our growth forecast for FY2018-19 from 7.2% to 6.7%.

Consumer prices will remain sticky as a weak currency and administrative price hikes will likely keep inflation above the RBI’s 4% policy goal within a band of +/-2%. We maintain our 4.7% inflation forecast for the current financial year.

With growth and inflation potentially moving in undesirable directions, the current tightening phase looks to be shorter. We have already pencilled in one more 25 basis point rate hike at the next meeting in October. This will still leave ample accommodation from the 200 basis points of rate cuts implemented over the last three years. Nonetheless, we don’t see any near-term respite from the ongoing upward pressure on government bond yields and the USD/INR exchange rate. Our end-2018 forecast USD/INR rate is 71.5 (spot 68.5).