FOR the first time in four years (and also the first time since Narendra Modi took over as Prime Minister), the Reserve Bank of India (RBI), the country’s central bank, hiked the key interest rate last week.

Though the hike was by a minimal 0.25 per cent, it was part of a bid to curb inflationary pressures triggered by high oil prices. India, which is highly dependent on imported oil, has been paying a hefty price following the recent surge in prices.

Estimates are that the oil import bill for 2018-19, originally pegged at $105 billion by the government (as against lower than $90bn last year) could even top the $150bn-mark, if the global price of the commodity continues to rise. Last week, of course, the price declined significantly.

The RBI noted though that since the last meeting of its monetary policy committee (the six-member MPC, which includes the governor, decides on the interest rates and other central bank policies at its bi-monthly meets), the price of the Indian basket of crude had soared from $66 a barrel to $74.

This was because of imports, which add up to 70pc of India’s oil consumption, becoming pricier. According to Dharmakirti Joshi, Chief Economist at Crisil — a leading Indian financial analytics company and majority-owned by S&P Global Inc — oil prices impact consumer inflation via first- and second-round effects in India.

First-round effects are felt immediately because of the market linking of domestic fuel prices to global prices. The asymmetry in excise hike and reduction (excise was raised when crude oil prices fell and are not being cut when they are raising) also implies higher first-round effects.

But the second-round effects “will depend on a continuation of growth momentum and whether the RBI maintains its fiscal 2019 growth forecast at 7.4pc,” Joshi adds.

With positive trends in the economy and inflation at the targeted rate of 4.8-4.9pc, many analysts were surprised by the RBI’s decision to raise the key interest rate

According to a report by Crisil Research, there is a possibility of another rate hike if the crude oil prices stay at current levels. “While monetary policy will stay vigilant, further policy rate action will most likely only be effected if the rise is perceived as being sustainable, with pressures suggesting seepage into generalised inflation through stronger domestic demand,” says the report.

The agency expects a 22pc increase in global crude oil prices in the current fiscal, on the back of an average increase of 18pc last year.

Of course, the soaring oil prices have not really raised inflation rates in India. The RBI, for instance, says that the retail inflation rose to 4.6pc in April, driven mainly by a significant increase in inflation excluding food and fuel.

“Excluding the estimated impact of an increase in house rent allowances for central government employees, headline inflation was at 4.2pc in April, up from 3.9pc in March,” the Crisil report adds.

“Food inflation moderated for the fourth successive month, pulled down by vegetables due to lower than the usual seasonal increase in their prices, and pulses and sugar which continued to experience deflation.”

THE timely onset of the south-west monsoon — one of the key aspects that shape inflation and the Indian economy for the rest of the year — has brought relief to policy planners.

The India Meteorological Department has predicted a normal monsoon this year, with strong rains during July. The monsoon has set in early this year, with Mumbai and the west coast of India already having witnessed heavy rains last week.

The RBI, in fact, retains the gross domestic product growth rate for 2018-19 at 7.4pc. “With improving capacity utilisation and credit off-take, investment activity is expected to remain robust even as there has been some tightening of financing conditions in recent months,” said the central bank.

“Global demand has also been buoyant, which should encourage exports and provide a further thrust to investment.”

Interestingly, quarterly data suggested that the economy grew at 7.7pc in the fourth quarter of fiscal 2017-18, which was the fastest over the last seven quarters.

Consumption both in rural and urban India remains healthy and is expected to strengthen further. Agriculture growth increased sharply in the January-March quarter with an all-time high production of food grains and horticulture.

And industrial growth has also strengthened, reflecting the robust performance of manufacturing, which accelerated for three consecutive quarters, says the RBI.

The output of eight core industries accelerated in April on account of a sharp expansion in coal production, which reached a 42-month peak. Cement output also posted a double-digit growth for the sixth consecutive month in April. But electricity generation has slowed down.

Growth in the services sector had been revised downwards because of slower expansion in many areas, but according to the central bank, it remained robust. “Various high frequency indicators also suggest resilient performance of the services sector,” it says.

“Improving sales of tractors and two-wheelers suggest strengthening of rural demand. Commercial vehicle sales also accelerated in April.”

With such positive trends in the economy, many analysts were surprised by the RBI’s decision to raise the key interest rate. Madan Sabnavis, Chief Economist at Care Ratings, says the decision to raise the repo rate by 25 basis points was surprising for two reasons.

The first is that it was being done with the expectation of inflation increasing in the coming months, though the targeted rate at 4.8-4.9pc is still below the 6pc upper band.

“This was not the stance taken earlier, even as inflation increased and expectations were in the upward direction,” Sabnavis notes.

And the second reason was that the RBI decision was unanimous by its MPC, which has rarely been the case in past policies.

Published in Dawn, The Business and Finance Weekly, June 11th, 2018