MUMBAI -- The Reserve Bank of India raised a key interest rate by 25 basis points on Wednesday as expected, pre-empting inflation risks such as unexpected fiscal measures taken by the central and state governments ahead of general elections early next year.
The central bank's monetary policy committee, led by RBI Gov. Urjit Patel, showed a sharp focus on inflation in Wednesday's 5-1 vote to raise the repo rate, which came even amid concerns that growth may slow in the second half of the year.
India's consumer prices have been rising since November. The retail price index reached a five-month high at 5% in June, mainly due to the weakening rupee and higher crude oil prices. The central bank now expects 4.8% inflation in the second half of the year, up from 4.7% projected earlier, with a further increase to 5% in April-June 2019.
The policy committee sees crude prices remaining vulnerable to both upside and downside risks, particularly geopolitical tensions and supply disruptions. The RBI also said in a statement that volatility in global financial markets continues to create uncertainty in the inflation outlook. Apart from these external factors, household expectations and the hardening of input prices could stoke inflation as well.
The RBI remains cautious about how the ongoing monsoon season will affect crops, and how the recent increase in minimum support prices for certain food grains will affect inflation. The central bank also said any "fiscal slippage" from spending by the central or state governments could harm "market volatility, crowd out private investment and impact the outlook for inflation."
Yet the central bank retained a projection of 7.4% growth in gross domestic product for the current financial year, with risks evenly balanced.
This second rate hike in two months comes as the government desperately wants low interest rates, high growth and sufficient resources to spend on boosting consumption ahead of India's 2019 election. But high fuel prices have upset consumers, while lower revenue collection and setbacks in divestment plans have limited New Delhi's ability to spend on populist programs without disturbing the country's fiscal deficit.
Any further loan waivers to farmers or fuel subsidies intended to keep prices low would impact the deficit and, in turn, increase inflation.
Sunil Kumar Sinha, director of India Ratings and Research, reckons that while New Delhi possesses little headroom to breach the fiscal deficit target under the country's Fiscal Responsibility and Budget Management Act, shifting spending to put more money in people's hands could boost inflation.
"What RBI has done today is to remain ahead of the curve by already raising the policy rates, which could to some extent take care of the inflationary expectations that are building up or any bonanza which the government might announce," Sinha said.
The RBI clearly intends to avoid any potential face-off later with New Delhi before the election.
"If one has studied and seen the RBI even before the [monetary policy committee] was constituted, they have shown that they are independent and do what is correct in their assessment," Sinha said.
Ratings agency CARE expects the RBI to hike rates once more during the financial year ending in March 2019, "dependent upon the inflation trajectory and on developments on the global front with regard to trade policies adopted by the U.S., monetary policy stance by major central banks and movement in the oil prices."