"Given the global conditions-rising oil prices, the Fed's rate policy, and the fact that other emerging markets have already begun raising rates-RBI should have probably raised rates earlier". The RBI had earlier cited "administrative exigencies" as the reason for the longer meeting.
The increase in repo rate comes as a bad news for those who have borrowed from banks because it is likely to lead to an increase in the interest they pay on loans, be it home loan, vehicle loan or personal loan. A hike in the interest rate reduces money supply and curbs demand, leading to lower prices.
Considering that the inflation outlook is pegged by the central bank at 4.7% year on year in second half of fiscal year 2019, two more rate hikes would take real policy rates to ~205bps from 165bps now.
But the big surprise was that the RBI continued to maintain a neutral stand on the rate cycle - indicating that future increases would be dependent on the trajectory of retail inflation which is now ruling at 4.58 per cent.
"The recent hike in crude prices and better GDP for the last quarter of FY18 suggest inflation trajectory may be on the higher side. The committee felt that there was enough uncertainty for us to stick to a neutral stance and yet respond to the risks to inflation target that have emerged in recent months", he told reporters after the monetary policy announcement.
The country's retail inflation rose to 4.58 per cent in April from a rise of 4.28 per cent in March and 2.99 per cent in the corresponding period of the previous year. When banks have surplus funds but have no lending (or) investment options, they deposit such funds with RBI. Bankers indicate the hardening of interest rates will continue as credit growth is gradually picking up.
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While the central bank has increased the inflation projection, it has maintained the "neutral" stance for monetary policy, meaning interest rates can move either way.
The fourth quarter estimate of Gross Domestic Product (GDP) released by the Central Statistics Office last month estimated the growth rate at 7.7 per cent, as against 5.6 per cent, 6.3 per cent and 7 per cent respectively in the first three quarters.
The RBI also revised upwards the retail inflation range to 4.8-4.9 per cent in the first half of 2018-19, and to 4.7 per cent in the second half, including the impact of house rent allowance (HRA) for central employees, and with risks on the upside.
A man checks his phone outside the Reserve Bank of India (RBI) headquarters in Mumbai, India April 5, 2018. Repo rate is short form of Repurchase Rate.
The RBI's decision to raise the rate comes in the wake of similar moves made by central bankers in Indonesia and Turkey.
To top this, foreign holders have sold a net $4.3 billion of Indian debt so far this year as investors have grown wary of emerging economies facing twin fiscal and current account deficits and higher inflation that could pose overheating risks. Higher rates will weigh on growth, but only with a lag.