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India hikes key rate for first time since 2014

Inflation fears prompt central bank to raise interest 25 basis points

Crude oil prices and expected U.S. Fed rate hikes prompt the Reserve Bank of India to raise its key interest rate.    © Reuters

MUMBAI -- The Reserve Bank of India on Wednesday raised its key interest rate by 25 basis points to 6.25% for the first time since January 2014 over fears of rising crude oil prices and spiraling inflation.

The six-member Monetary Policy Committee, headed by Reserve Bank Gov. Urjit Patel, decided to hike rates after an unusual three-day meeting. The committee was maintaining the repo rate at 6%, which was last cut in August. The decision had the unanimous vote of all members.

Patel noted that since the last policy review in April, the price of an Indian basket of crude surged from $66 per barrel to $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 and persistence in the higher Consumer Price Index projection for 2018-19,” he said. 

The committee maintained its inflation target for the first half of financial year that started April between 4.8% and 4.9%, while also keeping economic growth forecast for the financial year at 7.4%.

Indian consumers have already been dealing with higher prices and bank lending fees over the past few weeks. The rupee is also under pressure, while government bond yields have risen sharply.

Retail inflation in April rose to 4.58% from 4.28% in March, against the 4% mandated by the government. The inflation target is allowed a margin of plus or minus 2%.

Brent crude is swinging between $70 and $80 per barrel, which experts believe could be the new normal. External forces, such as surging crude oil prices and forecasts that the U.S. Federal Reserve may hike rates three more times, also stoked concerns.

Central banks in Asia have been raising interest rates as the Fed continues normalizing monetary policy, raising rates at a constant pace. Starting last year, South Korea, Malaysia, the Philippines, Singapore and Indonesia have all hiked rates.

India's growth beat expectations for the quarter ended March. Gross domestic product grew 7.7% year-on-year, the fastest pace in six quarters and well above neighboring China's 6.8% for the same period.

“The RBI’s decision to maintain a 'neutral' stance suggests that it does not want to signal that it is embarking on a tightening cycle and that it remains data dependent,” said a Nomura report. “We believe that both growth and inflation are likely to head higher in the coming months, paving the way for another 25bp rate hike in August.”

However, Nomura added, the ongoing tightening of financial conditions, higher oil prices and political uncertainty are likely to slow economic activity after September.

Ramesh Nair, CEO and country head of property research company JLL India said that even though higher interest rates are expected, the trend will still be closely watched as the government enters into the critical election year.

The Indian stock market appeared to have already factored in the interest rate hike and the benchmark index remained firm after the announcement. The Bombay Stock Exchange Sensex closed at 35,178.88, up 0.79% on the day.

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