7 JUNE 2018
On RBI’s repo rate hike
As inflationary trends harden, the RBI’s rate hike will quell uncertainty in the markets
At the end of an unusually long three-day meeting, the Monetary Policy Committee of the Reserve Bank of India opted for a hike in key interest rates by 25 basis points — the first such increase in four and a half years. This hike, the first during this NDA government’s tenure, was approved unanimously by the six-member committee, citing worries about hardening inflation trends and a firming up of growth recovery at home. Global uncertainties affecting emerging markets in particular have played a role as well — be it rising tensions over trade wars initiated by the Donald Trump administration or the strengthening dollar or further rate hikes by the Federal Reserve that could strengthen the exodus of global capital from emerging markets such as India. Already, between January and May, outflows from foreign portfolio investors have reached their highest level in 10 years, and by June 4, $6.7 billion was pulled out on a net basis from the domestic capital market. The rupee, along with other emerging market currencies, is hurting too, but RBI Governor Urjit Patel dismissed suggestions that the rate hike was a bid to stem outflows. The MPC, he asserted, is driven purely by its inflation management mandate, and there is no contradiction between the rate hike and the committee sticking to its neutral policy stance.
To be sure, while retaining its growth projections for 2018-19 at 7.4%, the MPC has revised upwards its inflation projections for the year since its April meeting — from 4.7-5.1% in the first half and 4.4% in the second half to 4.8-4.9% and a significantly higher 4.7%, respectively. This should worry a government gearing for parliamentary elections next year. Though seasonal food inflation spikes are delayed, input cost pressures have hardened owing to a spurt in global commodity prices, led by fuel. Moreover, inflationary expectations among producers as well as consumers have gathered steam. Crude oil prices have been the biggest factor at play, rising 12% from $66 a barrel when the MPC met in April to $74 a barrel. The committee said this rise is “sharper, earlier than expected and seems to be durable”, and termed it a major upside risk to its earlier inflation projections. Industry has expressed concern, but effective borrowing rates and bond yields had been firming up even before this rate hike. The government has, surprisingly, welcomed the RBI’s stance as one that could help steady the markets and dampen uncertainties. The RBI’s neutral stance, as Mr. Patel pointed out, allows it to keep all options open. But a reversal in rates is unlikely till global headwinds clear up and the mandarins in New Delhi work out a viable strategy to minimise the inflation transmission from global oil prices that is exacerbated by their taxation policy for fuels.
Defend the deal
On Iran nuclear deal
Iran should cooperate with Europe and China to work around U.S. sanctions
Iran’s notification to the UN that it would launch a plan to increase its uranium enrichment capacity illustrates the risks associated with the U.S. withdrawal from the nuclear deal last month. The Joint Comprehensive Plan of Action,reached among the five permanent members of the UN Security Council, besides Germany, the European Union and Iran, in 2015, curtailed Tehran’s nuclear programme in return for the lifting of international sanctions. But afterPresident Donald Trump withdrew the U.S. from the agreement and threatened to impose new sanctions on Iran, its survival is in question. For now, the other signatories say they remain committed to the agreement. But almost a month after Mr. Trump announced his decision, they are yet to come up with a framework to salvage the deal. The latest Iranian announcement is perhaps aimed at turning the heat up on European powers to come up with guarantees that the deal’s benefits will be in place even with U.S. sanctions. According to the deal, Iran can enrich uranium, but under tight restrictions. Iran now says it would open a centre for the production of new centrifuges at its Natanz facility, which could be used for enrichment. Tehran could argue that it is not technically violating the agreement as long as it does not produce centrifuges. But the move to open a production facility, that too soon after Supreme Leader Ayatollah Ali Khamenei called for preparations to speed up uranium enrichment, could be seen as a provocative step by the remaining parties to the agreement.
Instead of such posturing, both Iran and Europe would do well to shift their focus to preserving the integrity of the agreement. If Europe remains politically committed to the agreement as it claims, there have to be proper measures to circumvent the impact of U.S. sanctions. It is not yet clear whether European companies will make any significant investments in Iran, or even continue to do business in the country, once U.S. sanctions start targeting them. Earlier, European countries had discussed providing companies that do business with Iran special financing from the European Investment Bank and passing legislation to protect them from U.S. sanctions — but no decision has been taken so far. The EU says it can create conditions for Iran to continue to benefit from the deal but is wary of giving any guarantee. Iran has made it clear that the U.S. withdrawal should not affect its oil exports and access to the SWIFT international bank payments messaging system. The way forward is to continue a dialogue to find an economic and legislative package that would shield European companies and Iranian economic interests from U.S. sanctions. For that, Europe has to assure Iran it will stand up to U.S. pressure, as Iran remains cooperative and compliant with the terms of the 2015 agreement.