The arguments against an RBI rate hike
A no-action policy with neutral policy stance cannot be ruled out but accompanied by a hawkish language and even a marginal rise in the inflation projection for the second half of the fiscal year
In June, the Reserve Bank of India (RBI) raised its repo rate by a quarter percentage point to 6.25%, endorsed by all six members of the Indian central bank’s rate setting body, the monetary policy committee (MPC). The rate hike and a marginal increase in its inflation projection notwithstanding, the stance of the monetary policy was left unchanged—neutral. Which meant that RBI was not willing to signal a rate hiking cycle in India.
This was the story in June. Now, most analysts say there could be at least two RBI rate hikes, a quarter percentage point each, during the current financial year that ends in March 2019. The one-year overnight interest rate swaps, a derivative gauge where investors exchange fixed rates for floating payments, too indicates that.
While there is a near-consensus on the timing of the second rate hike (not before February 2019), economists and analysts are divided on the first of the two likely rate hikes—should it happen this week or at the next MPC meeting in October?
Those who expect a rate hike during the MPC meeting this week outnumber the votaries of an October hike. I belong to the minority camp.
Although it will be a close call, my take is RBI may prefer to wait for more data to go for the next hike, although unlike in June, all six members of MPC may not vote for the status quo.
Let’s see what has happened since June.
Retail inflation quickened from 4.87% in May to 5% in June, lower than what most expected, and the so-called core inflation or non-food, non-oil inflation rose to 6.4% from 6.2%, exceeding the upper end of the RBI’s inflation target band. Between 6 June when the last policy was announced and last Friday (27 July), oil price has remained virtually unchanged. From $74.96 a barrel, brent crude price dropped 0.56% to $74.54 a barrel.
The marginal decline in price is more than nullified by 2.5% drop in the value of the local currency during the period—from 66.93 to 68.6625 a dollar. This means the drop in the oil price will not have a positive impact on India’s import bill and change the balance of payment arithmetic. The biggest development which will influence the monetary policy committee discussion is, of course, the government’s decision to sharply increase the minimum support prices (MSPs) of 13 summer crops for the kharif season—the biggest such hike in the past five years.
On the growth front, signals are mixed. The June quarter earnings of listed corporations indicate improvement in operating margins but there aren’t visible signs of investment demand as yet, although consumption recovery is gaining traction. Indeed, credit offtake has picked up (12.8% year-on-year growth till 6 July vs 5.7% last year) but part of it could be attributed to non-banking financial companies accessing the bank funds instead of raising money from the market (which they had been doing) because of rise in corporate bond yield.
On the external front, the US Federal Reserve has been on course in raising the rate and the threat of trade war between the US and China has remained as real as it was two months ago.
Finally, many of the emerging markets—Indonesia, the Philippines, Turkey and Argentina—have hiked policy rates aggressively in recent past.
All these are fuelling expectations for a rate hike this week. However, there are equally compelling reasons for holding fire and preferring to observe how things unfold over the next couple of months. The sharp rate hike by some of the central banks in emerging market economies has been provoked by spiralling inflation and a rapid depreciation in local currencies. The Indian rupee is far less vulnerable than most other emerging market currencies. The core inflation also seems to have peaked in June and it is expected to slip before rising again from October-November. By October, clarity will emerge on the exact impact of the rise in MSPs of kharif corps and also the status of this year’s monsoon which has a bearing on food inflation.
If indeed RBI maintains status quo and adopts a gradual rate hike strategy, will it change its stance? Or, if a rate hike is on the cards, will it be accompanied a tightening stance, indicating more hikes in the future?
This is a delicate balancing act and it will be interesting to watch how the RBI wants to communicate with the market. I don’t rule out a no-action policy with continuation of the neutral stance but accompanied by a hawkish language and even a marginal rise in the inflation projection for the second half of the fiscal year.
Tamal Bandyopadhyay, consulting editor at Mint, is adviser to Bandhan Bank. His Twitter handle is @tamalbandyo. Comments are welcome at firstname.lastname@example.org
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