The RBI is expected to deliver a 50 bps rate hike in its September Monetary Policy Committee (MPC) meeting. The half a percentage point hike is expected as the Reserve Bank of India catches up with global central banks in not just fighting inflation, but also to stem rupee depreciation. RBI has already used up $100 billion in reserves to stabilise the local currency. “While this hike may help in allaying macrostability concerns, it would negatively affect the business cycle as nascent economic recovery may not be able to absorb such tightening of financial conditions,” said Edelweiss Securities in its report.
CPI inflation is still 1 per cent above RBI’s tolerance threshold of 6%, and the recent build-up in food price momentum and potentially lower agri output would also be discomforting for the central bank, the brokerage noted. “With the Liquidity Adjustment Facility (LAF) close to deficit now, the RBI MPC’s commentary on liquidity would be critical,” it said, adding that the pace of further hikes beyond the September meeting is dependent on the US Fed’s actions and food inflation.
Bank of Baroda Economist Sonal Badhan also expects RBI to raise repo rate by another 50 bps. “We maintain our growth and inflation forecasts. However significant risks to both have emerged,” Badhan said, adding that while risks to growth are driven by slowdown in global growth, risks to inflation are more domestic in nature. Other key developments which will be considered by the RBI will include volatility in the currency and bonds market. To comfort the yields and address the issue of temporary liquidity deficit, RBI may also announce OMO purchase calendar, she added.
Macro stability: Priority now
The US Fed’s resolve to fight red hot inflation is weighing on the balance of payments dynamic in large parts of the world. Forex markets are braving huge volatility with the dollar index surging to a 20-year high. Meanwhile, India’s external deficit remains quite large, and inflation too is above the comfort zone. “Consequently, the RBI is prioritising securing macro stability/exchange rate over growth at this stage by deploying forex reserves aggressively and persistently raising rates,” Edelweiss said.
Growth-inflation dynamic worsening
Aside from inflation, India is also facing growth headwinds from both global slowdown and a rapid domestic monetary tightening. Exports have already started to slow, which could impinge on India’s industrial production directly, according to the analysts. At the same time, aggressive use of forex reserves has eaten into liquidity surplus with sharp reduction in LAF surplus from Rs 8 lakh crore to near-zero now. “If this continues further, the current upswing in credit could be at risk,” they said.
On the inflation front, the recent spike in food price momentum is concerning amid the decline in rice and wheat stocks. Advance estimates also predict a decline in pulses and rice production. Besides, services inflation is also firming up. “Going forward, though non-food inflation would ease as demand fades, growth-inflation dynamics could remain adverse in the near term,” the brokerage said. It is worth noting that the MPC will start its three-day deliberations today, 28 September, and will announce its decision on Friday (30 September).