The Reserve Bank of India will announce its third bi-monthly monetary policy of the year on August 1. The central bank raised its benchmark repo rate (rate at which a country's central bank lends money to commercial banks) for the first time since 2014 in the last monetary policy committee (MPC) meeting in June and it was expected that with core inflation remaining above its inflation target and the looming impact of higher minimum support prices on agricultural produce, it would raise interest once again in August.
While many analysts still maintain the thought and see another 25 basis points (0.25 per cent) rate hike coming; whether it will be this time around or will the central bank wait and watch for data before increasing interest rate is being debated.
“The key reasons to hike are headline inflation remains well above the 4 per cent mark over the medium term, core inflation remains sticky and high along with risks of higher input prices being passed on over the next few quarters,” said Suvodeep Rakshit, senior economist at Kotak Institutional Equities.
Furthermore, he points out that economic growth remains on a strong footing and a closing output gap can further lead to inflationary pressures over the medium-term.
However, some say that while the tone of Reserve Bank will remain hawkish, there is a chance it could hit a pause as it watches a few developments that have taken place since the last MPC meeting and how it will impact on inflation and growth, going ahead.
Read how Inflationary pressures may prompt further tightening by RBI
The core inflation at 6.4 per cent in June surpassed the upper band of RBI's target. However, the government has recently lowered GST rates on several goods, which could lead to a moderation in core inflation, argues Manisha Sachdeva, associate economist at CARE Ratings.
Also, crude oil prices have seen a little decline since the last MPC meeting (from slightly over $75 to around $74 per barrel). Furthermore, Sachdeva opines that higher MSP may not necessarily result in a substantial rise in inflation and its impact will largely depend on procurement dynamics and supply-side scenario.
“While there is a case for RBI to go in for monetary tightening given rising inflation, likelihood of interest rate hikes by other central banks and higher economic growth, we believe that RBI will adopt a wait and watch policy and maintain a status quo," said Sachdeva.
Data is also pointing to a divergent trend. In June, retail inflation rose to a five month high of 5 per cent, but industrial production slowed to a seven month low in May. A further hardening of interest rates could impact investment plans of businesses over time.
Abheek Barua, chief economist at HDFC Bank does expect some impact of the MSP increases from September, but also feels there is a lot of uncertainty on the extent of pass through of higher MSPs.
“A lot would be dependent on the distribution of rainfall in the monsoon season, procurement of crops especially for items other than rice and wheat, and thus we believe it would be prudent for the RBI to wait and watch at this stage,” said Barua.
He further noted that the rise in food prices in June and July had been lower than the historical trend. Also, the rupee stabilising in recent weeks and the fall in oil prices could offer RBI some comfort.
Teresa John, economist at Nirmal Bang, pointed that the RBI had maintained a “neutral” stance in the last policy and that is indicative that it is not in a aggressive rate hike cycle.
John expects the RBI to increase the repo rate by 25 basis points in the second half of the current financial year, and feels “probability of back-to-back rate hikes is low.”
“We anticipate that the increase in MSP could push up inflation by about 50 basis points. Consequently, an upward revision in inflation forecast for second half of FY19 is likely. However, we expect the RBI to watch for more data before taking further action,” said John.
Sonal Varma, chief India economist at Nomura Securities says the Nomura RBI Policy Signal index, closely tracking RBI policy decisions, has remained firmly in the rate hike territory and “current macro economic conditions merit a 25 basis points rate hike in the forthcoming RBI policy meeting on August 1.”
However, Nomura also expects a long pause on interest rates there after as growth is likely to slow.
“Tighter financial conditions, slowing global growth and adverse terms of trade will start to constrain growth in H2 (second half) 2018,” said Varma.
Directions from global central banks will also have to be watched out for. The US Federal Reserve has already been tightening interest rates and while it may remain on hold this week, economists do broadly expect more hikes this year. The Bank of England too is likely to raise its interest rates.
Foreign institutional investors have been selling equity and debt from emerging markets, including India, this year in the wake of rates rising in the US and that will also weigh on India's central bankers.