Most economists expect the Reserve Bank of India (RBI) to raise the repo rate by 35-50 basis points (bps) in its policy meeting this week. The monetary policy committee (MPC) is scheduled to meet from August 3-5.
With consumer price inflation (CPI) falling to 7.01% in June, analysts expect the MPC to lower its inflation forecast of 6.7% for FY23. Earlier this month, RBI governor Shaktikanta Das said that inflation appears to have peaked, while cautioning that commodity prices remain high despite the softening trend observed in June.
The steady tightening of liquidity conditions in the banking system over the last few weeks is facilitating a faster accomplishment of the central bank’s policy goals, according to RBI watchers, and this could mean a shorter rate-hiking cycle than previously expected.
Rahul Bajoria, MD & chief India economist, Barclays, said system liquidity is now below the 1.5% of net demand and time liabilities (NDTL) threshold suggested by the central bank, leading to a spike in short-term money market rates. “Liquidity shrinkage and external benchmarking of loans continue to fuel the faster and complete transmission of rate hikes. That should make the MPC’s job easier, as it negates the need for a higher terminal rate,” he said.
Madan Sabnavis, chief economist, Bank of Baroda (BoB), expects the MPC to step back from its commitment to withdrawal of accommodation as there is little liquidity right now. “They will indicate the use of OMO (open market operations) to provide liquidity,” he said. Sabnavis expects a 25-bps hike in the repo rate.
Economists pointed out that though system liquidity has nominally fallen well below Rs 1 trillion, there is a sizeable amount of latent liquidity in the form of government balances with the RBI, estimated at Rs 3.5-4 trillion. The government’s expected spending behaviour, therefore, could have a bearing on the MPC’s actions.
Saugata Bhattacharya, EVP – business and economic research & chief economist, Axis Bank, said the neutral level of liquidity, earlier expected in December, seems to have kicked into the system much sooner. “That will have implications for how the RBI manages liquidity in the system, depending on how inflation and commodity prices pan out. That is something we’ll have to watch,” he said.
As consumer inflation shows signs of easing off, the rate-setting panel may take note of concerns around the external environment. The dollar has been strengthening amid rate hikes by the US Federal Reserve, putting pressure on the rupee, which has already touched the 80-mark against the greenback.
Upasna Bhardwaj, chief economist, Kotak Mahindra Bank, said that rate hikes could be frontloaded in the current cycle. “While some of the early signs of inflation moderation are visible, we believe that the external sector risks remain and to offset, at the margin, the increasing pressure on rupee, RBI should frontload the rate hikes even as the overall terminal rate may not eventually be very high,” she said. Bhardwaj expects the repo to rise to 5.75% by end-2022 from 4.9% at present.
However, Bajoria of Barclays believes the MPC will not concern itself with the exchange rate, relying instead on the government’s supply-side measures and the RBI’s forex market interventions to curb volatility in the currency.
Market indicators are showing signs of pricing in the end of the rate-hiking cycle. Analysts at rating agency Crisil said in a recent note that the overnight indexed swap (OIS) curve has undergone ‘bull-flattening’ since mid-June. “It shows the market is betting the Reserve Bank of India (RBI) could cut rates faster than expected once it is done with the rate hikes,” the note said.
According to Crisil, the ascent of the OIS rates since the beginning of the year was prescient in that it revealed market expectations of the RBI hiking the repo rate faster than communicated. The MPC effected its first repo rate hike of 40 bps in an off-cycle meeting in May, taking markets by surprise. This was followed by a 50-bps hike in the June policy.