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The Reserve Bank of India’s (RBI’s) October policy takes place against a markedly uncertain domestic and global backdrop. Domestically, growth momentum remains weak, a trend we expect to continue. Growth in the second quarter of 2013-14 was just an annual 4.4%, and weakness remains widespread, including some of the usually stable segments such as domestic services and private consumption. In fact, excluding government spending, which was somewhat stronger during April-June, real gross domestic product (GDP) grew merely 3.7% year-on-year.

The monsoon was good this year, which will likely support consumption to some extent in the coming months. However, the broader trend in manufacturing and mining remains sluggish, despite sporadic upside surprises.

The likely elevated interest rate trajectory is also emerging as another headwind for industrial growth. Moreover, the government’s fiscal health is once again coming under pressure, which could act as a constraint for spending during the second half of 2013-14 as the government remains committed to its fiscal deficit target of 4.8% of GDP. The national elections, due by May, are another source of potential uncertainty for the economy and, in our view, will be a headwind against a revival of the investment cycle. Taking all such factors into account, we expect GDP to grow just 4.7% in the year to March.

Inflation also sprang some unpleasant surprises of late as the Wholesale Price Index (WPI) reached 6.5% in September from sub-5% in June. The new governor clearly wants to reinforce the central bank’s inflation-fighting credentials to better anchor inflationary expectations. At the moment, WPI is running at 6.5%, above RBI’s desired level of around 5.5% for the year. Retail inflation remains stubborn at about 9.5%. Interestingly, while core inflation (sub-2%) is considerably softer and the recent increase in WPI and the Consumer Price Index has been more due to supply-side issues such as food inflation, the central bank remains worried about the potential adverse impact on medium-term inflationary expectations.

While the growth-inflation dynamics remains markedly unfavourable, some relief for policymakers is emerging on the external account front. Current account deficit, a key problem in recent years, has improved rapidly in recent months. We think the current account deficit could be less than $60 billion in 2013-14, down from $88 billion in 2012-13. A number of factors, including a smaller merchandise trade deficit, a steady increase in services exports and remittance inflows, are narrowing the current account gap.

The weakness in the rupee is also a factor facilitating a faster re-balancing of the trade and current account deficits. Such an improvement would mean India could almost fully fund its current account deficit in 2013-14. The delay in tapering of bond purchases by the US Federal Reserve is another near-term positive for the local currency.

Sentiment has also improved significantly since early September after RBI announced policies to attract near-term capital flows. Accordingly, on balance, we expect the rupee to have a stable to positive bias over the near term, and we forecast the currency to be worth 61 to a dollar over the next three-six months.

The recent trend in macro indicators has, therefore, added to further complications for RBI. Currency stability has given the central bank room to unwind extraordinary liquidity tightening measures relatively quickly. On the other hand, we expect RBI’s surprise September repurchase (repo) rate hike, by and large, to be a one-off rather than the first of a series of hikes. The repurchase rate is a measure of funding availability in the banking system. After all, the growth outlook remains depressed and rise in prices may moderate in the coming months once food inflation softens.

As the central bank seems keen to send a stern inflation-fighting message, we acknowledge the risk of one more repo rate hike next week or in during RBI’s December policy; while our base case expectation remains that of a flat repo rate (at 7.5%) trajectory in the coming months.

The author is chief India economist at Barclays Plc.

RBI will announce its second-quarter monetary policy review for fiscal 2014 on 29 October. This is the third and last in a series of articles by economists on what to expect from the policy.

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