Here’s why India’s central bank is hiking rates consecutively for the first time since 2013

• On 1 August, five of the six members of the RBI’s monetary policy committee voted in favour of a second consecutive rate hike.
  
• The resulting repo rate, 6.5%, is the highest rate in two years, indicating the central bank’s desire to keep inflation in check.
  
• Domestic banks will pass on the higher rates to borrowers and depositors in the form of costlier loans, higher EMIs.
  
  

To almost no one’s surprise, the monetary policy committee of the Reserve Bank of India (RBI) hiked the repo rate, the rate at which it lends money to banks, by 0.25 basis points to 6.5% on 1 August. The move came less than two months after it hiked rates to 6.25% at its last meeting in June.

This was first time since October 2013 that the central bank had decided on consecutive rate hikes, indicating the need to keep inflation in check and prevent the further depreciation of the rupee.

All about inflation

The RBI’s big worry, as usual, is rising prices - both headline and core inflation have inched upwards since the June meeting. It expects the rate of inflation to rise to 4.8% in the second half of the current financial year and touch 5% by the first quarter of fiscal 2020.

Urjit Patel, the governor of the central bank, pointed out the inflationary pressures of the central government’s minimum support price (MSP) schemes. The MSP has been fixed at 150% of the cost of production of all kharif crops, and high price of fuel - both of which are leading to higher household costs.

The idea behind the two rate hikes is to encourage saving and reduce the supply of the money circulating in the Indian economy, thereby moving the rate of inflation down to the central bank’s long-term target of 4%. In an election year, the central bank probably wishes to prevent overspending by the government.

The RBI was not too worried about hurting domestic growth, given the solid monsoon, a rebound in private investment, a good earnings season for India Inc and the potential rise in rural consumption as a result of the MSP scheme. It kept its GDP forecast for the year unchanged at 7.4%.

Higher EMIs, higher credit costs

Domestic banks will pass on the higher rates to borrowers and depositors in the form of costlier loans and higher equated monthly installments (EMIs). The SBI hiked deposit rates a day before the meeting of the monetary policy committee. Earlier this year, in June, a number of banks, including ICICI Bank, SBI and Punjab National Bank, increased lending rates before the June rate hike.

A major casualty of the double rate-hike will be the housing market, given the higher cost of mortgages and home loans. Hence, the real estate sector will remain sluggish as rate-conscious buyers steer clear.

Another rate hike before year’s end?

Two consecutive rate hikes usually point the commencement of a tightening cycle. There remains a high possibility that the RBI will hike rates again before the year is over if the 4% inflation goal isn’t met. The recent GST rate cut on a number of items could result in lower retail inflation, which will be countered by the upward effect of the MSP scheme on food inflation.

The central bank decided to keep its policy stance “neutral”, however, likely in light of trade tension between the US and China. In the event of a trade war and an ensuing depression in global growth, the RBI will likely hold rates stable to encourage consumption.