On Wednesday, at 1 August, the RBI(Reserve Bank of India) monetary policy committee may raise the benchmark reference rate by a quarter percentage point. This is for the second time in two months. Due to inflation risks mounts RBI likely to go for 25 bps interest rate high.
Several factors affect an increase in deterioration in inflation outlook like falling in crude oil and food prices, volatility in global financial markets, low minimum prices for support.
In accordance to the 15 economists surveyed, 12 expects RBI to raise its repo rate high, the rate at which it lends to commercial banks to 6.5 %, only 3 expects RBI to keep rates unchanged at 6.25 %.
Reasons made necessary for RBI to rates high are:
1. Core inflation comes forward, again:
Core CPI(Consumer Index Price) rose to 5% in June, slower than 5.3% but faster increase than 4.87% in May. Core CPI, excluding food and fuel, accelerated to 6.4% from 6.2% in May, while global crude prices have declined, it is still hovering above $70 per barrel that is in the range of $72-74 a barrel.
2.Less support, high inflation
Higher MSP(Minimum support price) is a danger to inflation. Hike in MSP for agriculture this time steeping comparison to previous averages. Impact of MSP will depend on how much government procures. After the immediate coming of MSP, food inflation would be declined and this is not so far.
3. Oil is simmering if not boiling
Global crude oil prices are a big changing factor in the behavior of domestic inflation, something RBI has also indicated. Oil prices have stabilized since the June policy. But this should not cloud the fact that oil prices are far above the comfort level of the central bank. Moreover, there is no guarantee crude will continue to behave, as geopolitical tensions continue. Global growth continues to be robust, which will mean increased demand for oil. And with China relaxing its monetary policy, prices of metals should also start to climb.
4.Mind the gap
Notice the significant shift in language in the June policy, with the most dovish member of the monetary policy committee, conceding that the output gap—the gap between the level of economic activity and its potential—is closing. That points to two things—one, capacity is becoming a constraint, which means businesses will raise prices when faced with strong demand; and two, the economy is strong enough to absorb a rate hike.
5.Vote for populism
The Lok Sabha elections in 2019 make it hard for any government to ignore populist measures. Such measures can be tempered by the central government, but states may be hard-pressed to avoid them, especially if monsoon plays truant. Already, 10 states have received scanty rainfall, making a case for farm loan waivers. Fiscal prudence is unlikely to be a top priority and RBI needs to pre-empt this. Ergo, a rate hike.
All these factors threaten the sanctity of the 4% inflation target, which RBI wants to maintain at any cost.
Monetary Policy is about more than just the current situation. The signaling function is of policy is forward-looking and is articulated to anchor inflationary expectations at least a year.
According to the report, RBI will maintain its neutral policy stance. During the previous policy of RBI, its future rates moves would be a data dependent.
A rate will reaffirm its commitment toward the inflation targeting framework and play an important role in reducing risks to macroeconomic stability amidst several global uncertainties.
The average inflation for 2018-2019 now stands at 4.8%-4.9% in the 1st half and 4.7% in the second half.
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