RBI most likely to hike repo rate for third time in upcoming policy meet

In the previous monetary policy announcement in August, the Reserve Bank of India raised its benchmark repo rate by 25 basis points (0.25 per cent) and the wider expectation among economists then was that the central bank would take a breather after two consecutive rate hikes. But, with things deteriorating further on two key fronts—currency and crude oil—another 25 bps interest rate hike may be upon us in the upcoming monetary policy announcement on Friday.

The repo rate in India currently stands at 6.50 per cent, after two interest rate hikes this year. Since the last monetary policy committee (MPC) meeting, India's economic growth has picked up pace while consumer price index (CPI) inflation eased in August. However, there's a double whammy from currency; the rupee breached the 73-mark against the dollar hitting an all time low of 73.34 on Wednesday; and crude oil prices are at near four year peak.

With crude oil prices rising, petrol and diesel prices at pumps across India have hit a record too, for instance, petrol breached Rs 91 to a litre in Mumbai,. On the other hand, a falling rupee (it has depreciated 7 per cent since the last MPC meeting), will mean prices of imported goods and raw materials will also continue to rise. Higher crude oil prices as well as depreciating rupee will pose upward risks to India's inflation.

Furthermore, the United States is clearly moving away from its previous accomodative policy stance. The US Federal Reserve last week raised the benchmark overnight lending rate by 25 bps to a range of 2.00 per cent to 2.25 per cent and sees another rate hike this year. This will have a bearing on our economy as more foreign institutional investors (FII) will pull money out of India and other emerging markets back to the US.

All these factors could leave little choice for the MPC headed by RBI Governor Urjit Patel, but to raise repo rate further this time.

“It seems like the stage is set for yet another rate hike. Will this hat-trick be accompanied by a change in stance is the key thing to watch out for,” said Lakshmi Iyer, chief investment officer (debt) at Kotak Mahindra Asset Management.

Between January and October this year, FIIs have pulled out Rs 63,865 crore from India's equity and debt markets, according to data from depositories.

A widening current account deficit due to the sharp rise in crude oil prices, the foreign fund outflows amid rising interest rates in the US and global trade tussles have weakened the rupee.

The government raised import tariffs recently to curb the current account deficit and also waived withholding tax on interest payments on the rupee denominated masala bonds, as a part of measures to stem the slide in rupee. The RBI too has sold dollars worth over $16 billion this financial year as it looks to shore up the currency.

However, all these measures have not substantially stabilised the rupee, notes Madan Sabnavis, chief economist at CARE Ratings.

The 10-year G-Sec (government securities) yields have moved up quite sharply since the last policy that has led banks to mark MTM (mark-to-market) losses, further pressurising their situation. These various factors would drive RBI to hike interest rate, said Sabnavis.

RBI had projected retail inflation at 4.6 per cent in the July-September quarter and at 4.8 per cent in the second half of the year ending March 2019, which could now be revised upwards.

“CARE Ratings expect a 25 bps repo rate hike and a 25-50 bps reduction in CRR (cash reserve ratio) by the RBI in the forthcoming monetary policy. There could be an upward revision in the inflationary projections for the year on account of higher oil prices, increase in MSP (minimum support price on agri produce) and imported inflation (on back of rupee depreciation),” added Sabnavis.

Despite the consecutive rate hikes, the central bank has thus far maintained a “neutral” stance. Some expect that this position could also change with another rate hike.

“In the forthcoming policy, RBI is likely to raise the policy repo rate at least by 25 bps. We rule out a hike of 50bps, as it may spook the market. However, there is an outside probability of change in neutral stance too, as three successive rate hikes with a neutral stance could contradict RBI message,” said Soumya Kanti Ghosh, group chief economic adviser at State Bank of India.

The MPC meeting began today and the policy announcement will be made on Friday. Beyond the interest rates and inflation outlook, all eyes will be on further measures, if any, by the central bank to control the fall of rupee. RBI's views on the overall state of financial markets and the liquidity situation will also be keenly looked out for.

Several defaults by infrastructure financing giant, Infrastructure Leasing & Financial Services, had jolted financial markets recently, with investors selling off stocks of non-banking finance companies amid concerns over short-term liquidity. The government stepped in on Monday, replacing the board of directors of IL&FS with a new board led by Uday Kotak, managing director of Kotak Mahindra Bank.

The RBI too has already announced that it will conduct open market operations to buy Rs 36,000 crore of bonds to infuse liquidity in the market.