With inflation on rise, RBI unlikely to cut interest rates further: Analysts

rbi-reuters-2012 [File photo] The RBI left the benchmark repo rate unchanged at 6.25 per cent on April 6 in its first bi-monthly monetary policy announcement for financial year 2017-18 | Reuters

The central bank could even surprise with interest rate hikes in 2018

The Reserve Bank of India, which maintained status quo in the recent monetary policy announcement, may not find room to cut interest rates further in the wake of inflationary pressures, say analysts, citing hawkish commentary from some of the monetary policy committee (MPC) members. The central bank could even surprise with interest rate hikes in 2018, said at least one analyst.

The minutes of the last MPC meeting released show five of six members raised concerns over rising inflation. Michael Patra, the central bank's executive director, even suggested a pre-emptive 25 basis points hike in interest rate, if the RBI was to meet its four per cent inflation target.

“I believe that a pre-emptive 25 basis points increase in the policy rate now will point us better at the target of four per cent to which the committee has committed explicitly. It will also obviate the need for back-loaded policy action later when inflation is unacceptably high and entrenched,” Patra stated.

Data released by the government earlier this month showed India's consumer price inflation rose 3.81 per cent in March, its highest level in the past five months, driven by higher fuel costs. There are also concerns that food prices may rise if India receives below-average monsoon rains this year.

Patra's statement has surprised market experts, who feel that inflation is only expected to rise by the fourth quarter of 2017 and hence, talks on a rate hike at this stage was not expected.

“The minutes of the RBI's April 6 policy meeting suggest that the next move will likely be a hike... The call by one of the members for a pre-emptive rate hike is a surprise. Although we believe this will be necessary in 2018, we did not expect it to be mentioned just yet,” said Sonal Varma, chief India economist at Nomura Financial Advisory & Securities (India).

Nomura expects inflation will rise sharply to around 5.5 to six per cent by the October-December quarter and in the first half of 2018 as cyclical factors such as narrowing output gap, stronger rural wage growth and adverse base effects push it higher.

“We have changed our policy call and now expect a cumulative 50 basis points rate hike in 2018. We also believe that surplus liquidity will persist and hence expect 100 basis points cash reserve ratio hike in the second half of 2017,” said Varma.

The RBI  left the benchmark repo rate unchanged at 6.25 per cent on April 6 in its first bi-monthly monetary policy announcement for financial year 2017-18.

It raised the reverse repo rate to six per cent, as it looks to mop up the excess liquidity in the system. Repo rate is the rate at which RBI lends funds to commercial banks, while reverse repo is the rate at which the central bank borrows money from commercial banks. 

“Headline inflation is likely to remain higher than the (RBI's) medium-term target of four per cent. Further, sticky core inflation leaves limited scope for further easing with growth expected to improve marginally,” said Madhavi Arora, economist at Kotak Mahindra Bank.

She expects the RBI will maintain status quo throughout the year ending March 2018.

MPC members seem to be watchful of the inflationary impact of the second round of increase in house rent allowances prescribed by the seventh pay commission. 

“While we should see through any statistical effects from an increase in the HRA, the size of the second round effects may potentially be large depending on the extent and manner in which the HRA implementation takes place, in which case, there may be a need for a monetary policy response,” said Chetan Ghate, professor at the Indian Statistical Institute and one of the three external members of the MPC.

RBI's focus on meeting the medium-term inflation target needed to be “laser sharp” given such risks, he added.

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Topics : #RBI | #Inflation

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