The Reserve Bank of India (RBI) hiked its benchmark repo rate for the first time in four years on Wednesday in an effort to curb inflationary pressures, but maintained a neutral policy stance.

The central bank’s monetary policy committee increased the repo rate by 25 bps to 6.25% and the reverse repo rate to 6% from 5.75%, but markets took cheer from its neutral stance which indicates that this rate hike does not signal more rate hikes to come.

RBI governor Urjit Patel told reporters the committee “felt that there was enough uncertainty for us to keep to the neutral stance and yet respond to the risks to (the) inflation target that have emerged in recent months”. He added that the rate hike and neutral stance are not contradictory moves: “A neutral stance leaves all options open”.

The rate hike, the first since January 2014, comes amid increasing worries about rising crude oil prices and a weakening rupee, but it suggests the economy is recovering from the hit it took after demonetisation.

Interest rates on deposits and loans may inch up as we expect further tightening of rates in the coming months.
Rajiv Sabharwal, MD & CEO, Tata Capital

The RBI revised its inflation projection for the first half of 2018-19 to 4.8-4.9% and to 4.7% for the second half. In April, the committee had projected inflation in the first half at 4.7-5.1% and 4.4% in the second half.

The central bank added that risks of inflation were tilted to the upside given rising crude oil prices and the implementation of a higher minimum support price (MSP) for food crops.

It retained its GDP growth forecast for this financial year at 7.4%. Patel said the forecast of a normal monsoon this year augurs well for the economy and RBI expected investment activity to remain robust.

“The MPC notes that domestic economic activity has exhibited sustained revival in recent quarters and the output gap has almost closed…Investment activity, in particular, is recovering well and could receive a further boost from swift resolution of distressed sectors of the economy under the Insolvency and Bankruptcy Code,” the central bank said in a statement. “Consumption, both rural and urban, remains healthy and is expected to strengthen further.”

Rajiv Sabharwal, managing director and CEO of Tata Capital, said “an interest rate hike was imminent amid good GDP growth numbers in the fourth quarter of 2017 -18”. He added that persistent rise in crude oil prices raised inflationary expectations, forcing the RBI to increase rates. “Interest rates on deposits and loans may inch up as we expect further tightening of rates in the coming months,” Sabharwal said.

V.K. Sharma of HDFC Securities called the rate hike “a step in the right direction”, adding that the confidence shown by the RBI in the economy is a positive. “Despite inflationary pressures, the RBI has stuck to its growth projections and guided for robust investment activities for FY19,” Sharma said.

Rana Kapoor, managing director and CEO of Yes Bank, said the rate hike along with the neutral stance allows the RBI to act in accordance with evolving macro conditions.

“Amidst many moving parts, this will entail a careful balancing of global headwinds from elevated crude prices, geopolitical tensions, and domestic policies of MSPs, state pay commissions on growth-inflation dynamics,” he said.

Naresh Takkar, MD and group CEO of ICRA, was of the view that hardening bond yields and monetary tightening may push up bank lending rates further. “Interest costs are likely to rise in the current fiscal, which would weigh upon margins as well as the strength of the investment recovery in FY19,” he said.

Markets fell sharply immediately after the rate hike was announced, but settled down after the RBI maintained a neutral stance. The Sensex fell from 35,127 at 2.31 p.m. to levels of 34,978 at 2.35 p.m. However, the Sensex then rallied over 200 points and ended the day 0.79% higher than the previous close.

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