Making money more expensive, for the second time in two months, the six-member Reserve Bank of India’s Monetary Policy Committee (MPC) on Wednesday raised its benchmark interest rate by 25 basis points (bps) on inflationary concerns, a move that will make home, auto and other loans expensive.


The RBI’s raised the repo rate by 25 basis points to 6.50 percent. It is the first time since October 2013 that the rate has been increased at consecutive policy meetings.In June, the MPC also increased the key rate by 25 bps.


A hike in repo rate will have a direct impact on borrowers as banks are likely to increase interest rates on loans in tandem. This is because a hike in repo rate will mean that banks' marginal cost based lending rate (MCLR) in all likelihood will go up. Since the start of the year, many banks have been increasing their MCLR. 


According to the central bank's mandate, all loans including home loans disbursed on or after April 1, 2016 should be linked to MCLR. Banks are free to decide to decide whether to charge additional mark-up over and above MCLR or not. However, the lending rate cannot be below the MCLR. 

While the RBI on Wednesday marginally trimmed its inflation projections for the current quarter, the central bank said its inflation projections beyond that remain “broadly unchanged”.


India’s annual consumer inflation hit 5 percent in June, the eighth straight month in which it topped the RBI’s medium-term 4 percent target.

For July-September, it pegged CPI-based retail inflation at 4.2 per cent which it saw firming up to 4.8 per cent in the second half of the current fiscal.


The projected inflation rate is above its targeted comfort level of 4 per cent. The RBI retained the GDP forecast for the current fiscal at 7.4 per cent on robust corporate earnings and buoyant rural demand, though it flagged global trade tensions for Indian exports. It also saw the GDP forecast at 7.5-7.6 per cent in the second half of the current fiscal.


“The swiftness with which the central bank has responded to the jump in inflation should prevent the need for very aggressive policy changes in the future,” Capital Economics analyst Shilan Shah said in a note.


A high repo rate means that banks borrow funds from the RBI at a higher rate, increasing their cost of funds. Credit growth is also picking up. Credit to various sectors, including agriculture, has risen 12.3% year-on-year data available as of July, according to Bloomberg.


With deposits rates going up and liquidity remaining tight, analysts say banks may eventually pass on higher cost of funds to borrowers. India’s largest bank SBI last month hiked interest rates on retail deposits and longer-term bulk deposits.


Kunal Shah, , Fund Manager – Debt, Kotak Mahindra Life Insurance said, the MPC voted for raising interest rate by 25bps to 6.50 per cent 5-1 vote, the move was in line with market expectations.


“As we had expected, the policy guidance has been on a neutral side. RBI has maintained inflation expectations for full year to 4.75% and continues to see growth reviving to 7.4% sighting investment rate revival. The rate move and inflation projection is largely due to volatile crude oil prices, higher credit off take and virtual closure of output gap as per the committee,'' he said.


Sampath Reddy, CIO, Bajaj Allianz Life, said,“The RBI maintained that uncertainty still remains on the inflation front and it needs to be monitored closely.We feel that future monetary policy action will continue to be data dependent.”

The bank’s decision to raise rates comes as global central banks, such as the U.S. Federal Reserve, the Bank of England and the Indonesian central bank also adopt a tightening path.


The Fed, which is expected to keep rates on hold at a two-day meeting that ends later on Wednesday, has already raised rates twice this year, while the Bank of England is poised to raise rates at a meeting on Thursday.


Global crude oil prices have surged nearly 20 percent this year and crossed $80 a barrel in May, their highest since 2014.


This has driven the prices of fuel – the biggest item on India’s import bill – to record highs at a time the rupee is testing new life lows, raising the threat of imported inflation.


Indian monsoons, one of the largest determinants of the inflation path, have been erratic and patchy in several regions this year, muddying the outlook for winter-harvested crops and adding to inflationary pressures.



The MPC warned that “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.”


At a news conference, RBI Governor Urjit Patel said “We’ve already had a few months of turbulence behind us and it looks like that this is likely to continue. For how long, I don’t know.”


The governor said trade skirmishes have “evolved into tariff wars and now we’re possibly at the beginning of currency wars. Given this, we have to ensure that we run a tight ship on the risks that we control to maximise the chances of ensuring macro-economic stability and continuing with the growth profile of 7-7.5 percent.”