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Inflation concerns forced the Reserve Bank of India (RBI) to raise repo rate for the second time in a row by 25 basis points to 6.5 percent on Wednesday. As a result, reverse repo rate now stands at 6.25 percent.
Repo rate is the rate at which the RBI lends money to banks while reverse repo is the rate at which the RBI borrows money from banks.
While maintaining GDP growth projection at 7.4 percent, the central bank raised its inflation estimates to 4.8 percent from 4.7 percent for the second half of FY19 and introduced 5 percent inflation rate for first quarter of FY20 while listing many uncertainties and its impact on the inflation like the effect of MSP on farm produce, volatility in global financial markets, staggering impact of HRA revision by State governments and which all will be tracked very closely.
The early announcement of inflation projection for the next financial year indicated that there could be more risk to its the medium-term target for consumer price index (CPI) inflation of 4 percent within a band of +/- 2 percent, though the RBI has a Neutral stance with intention of keeping itself ahead of the curve.
The Monetary Policy Committee noted that domestic economic activity has continued to sustain momentum and the output gap has virtually closed, but uncertainty around domestic inflation needs to be carefully monitored in the coming months.
"In addition, recent global developments raise some concerns. Rising trade protectionism poses a grave risk to near-term and long-term global growth prospects by adversely impacting investment, disrupting global supply chains and hampering productivity. Geopolitical tensions and elevated oil prices continue to be the other sources of risk to global growth," it reasoned.
Majority of experts feel there could be at least one more rate hike in the offing which could happen in any of the policy meeting in FY19, while few are saying neutral stance indicated that there could be long term pause for further rate hike and rate hike in medium term is only possible if inflation goes beyond MPC's expectations.
Experts who are in the boat of another rate hike likely said RBI, in its June policy meeting, also had a neutral stance and hike rate by 25 basis points to 6.25 percent and today also it raised rate by another 25 bps to 6.5 percent with keeping neutral stance, which indicated that there could be more inflation risk going ahead.
"We are away from 4 percent inflation target for some time now," the RBI governor said. "This in itself indicates an inflationary trend and we could be in for some surprises on the upside in repo rates," Raj Mehta, Fund Manager, PPFAS Mutual Fund said.
He further said the direction and the trend of interest rates will remain upwards in the near future through the quantum and the frequency of rate hikes remain uncertain. "We think RBI's statement seems more hawkish than its stance on inflation and inflationary risks."