RBI monetary policy meet: Weak rupee, higher oil prices; why RBI may hike repo-rate by 25 bps

Updated: October 4, 2018 6:21 PM

RBI has also continued to infuse liquidity through open market purchase of government securities, fiscal year-till date RBI has purchased Rs 50,000 crore worth of government bonds.

RBI monetery policy review begins, may raise rate by 0.25 percentThe October MPC policy is the most awaited policy amidst sharp depreciation on currency .

Kunal Shah

The October MPC policy is the most awaited policy amidst sharp depreciation on currency since the previous meeting, this time around RBI has been away from using any interest rate defense to protect the currency like in 2013. The thought to not use interest rate tool would be supported by lower inflation in the economy compared to 2013.

Surprisingly CAD has deteriorated towards 2.5% when inflation was within 4% range in last 4 years and real rates near 2%, higher deficit thus reflects weaker sensitivity to real rates and driven largely by discretionary spend on electronic items and higher crude oil prices. And hence, the government have recently announced hike in duties on certain items to control demand.

We feel MPC may consider the impact of currency depreciation on consumer inflation and hence may hike rates by 25 bps to 6.75%. CPI has been printing 20-30bps lower than RBIs estimate and has averaged 4.47% in five months of this fiscal, with 12% depreciation in currency the final average inflation would be closer to 4.80-5% mark. The need for a hike in interest rate will purely be basis weaker external environment and to keep real rates high to support currency and capital flows.

Another development this time is in credit markets, RBI along SEBI’s release have shown inclination to intervene if required. RBI has also continued to infuse liquidity through open market purchase of government securities, fiscal year-till date RBI has purchased Rs 50,000 crore worth of government bonds. Economist see FY’19 to end with BoP deficit of between $20-30bn, along with such deficit and increase of currency in circulation RBI is seen to infuse large quantum of reserve money to fund the economic growth. Estimates of OMO purchases are between Rs 1.5-2 trillion.

From the bond markets point of view, the year so far has been taxing as yields have jumped from 7.40% to 8.20%. Hardening of global interest rates and crude oil prices has added to worries on monetary policy and fiscal deficit. The sharp fall in currency made the matters worse. Purely from domestic inflation point of view such sharp jump in yields were not expected.

Good news is government has assured to maintain fiscal deficit at 3.3% sighting better tax collection and has in fact reduced gross market borrowing to 5.34trn from budgeted 6.06trn. The lower borrowing by government and lower inflation prints will keep yields in range for now. Markets are factoring in 25bps rate hike in coming policy and will take cues from the forward guidance. Amid all above factors we see the 10y benchmark to trade in 7.75-8.15% range for a while as currency has also stabilized.

(The author is Fund Manager, Debt at Kotak Mahindra Life Insurance Limited. Views are the author’s own.)

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