Photo: Ramesh Pathania/Mint
Photo: Ramesh Pathania/Mint

RBI may raise policy rates by 25bps on Friday, say economists

While a rate hike is unanimous next week, most economists expect one more hike before the end of 2018-19

The Reserve Bank of India’s (RBI’s) monetary policy committee (MPC) may raise policy rates by 25 basis points on Friday, for the third time this year, along with a change in stance to a hawkish one, amid surging crude oil prices and weakening rupee. Of the 15 economists surveyed by Mint, 14 expect RBI to raise repo rate, the rate at which it lends to commercial banks, to 6.75%. Only one economist expects a 50 basis points hike to 7%.

A basis point is one-hundredth of a percentage point.

Since the last policy in August, the upward pressure on RBI’s 4% inflation target has increased with rupee depreciating by 5.5% and oil prices rising by 13%. In addition, customs duty has also been raised on goods worth $12 billion. This, even as consumer inflation has remained lower than RBI estimates and core inflation momentum has slowed down.

“We expect RBI to emphasize on the forward-looking nature of monetary policy, as high oil prices and a weak rupee risk hardening inflationary expectations and disrupt the benign inflation outlook. External challenges stem from US monetary policy normalisation, just as oil prices are rising sharply. At home, volatile financial markets have kept the rupee at record lows. For the rupee credit markets, spillover worries from a domestic non-bank financial institution’s default continues to hurt risk-appetite," said Radhika Rao, economist at DBS Bank.

In the previous policy, MPC members reasoned that inflation will increase in the second half of the year, given uncertainties around the implementation of the minimum support price (MSP) and crude oil prices. Accordingly, RBI revised its consumer inflation projection for the second half to 4.8% from 4.7%. The central bank expects it to further rise to 5% in the first quarter of next fiscal. Economists expect RBI to wait for clarity in MSP hike increase before revising the inflation target upwards.

While a rate hike is unanimous next week, majority of economists expect at least one more rate hike before the end of fiscal year 2018-19. MPC members in the minutes of August policy meeting had expressed concerns about meeting the medium term inflation target of 4%.

“We expect a change in stance to withdrawal of accommodation. This would signal the possibility of another rate hike in December 2018, unless key inflation risks such as crude oil prices and the INR record an appreciable reversal in the intervening period," said Aditi Nayar, principal economist at Icra Ltd.

While majority of economists expect RBI to maintain the neutral liquidity stance, some economists expect RBI to hike cash reserve ratio (CRR) or provide liquidity support for non-banks and mutual funds in the midst of spillover worries from a domestic NBFC’s default. According to a PTI report dated 25 September, an unnamed government official has suggested that RBI should consider hiking CRR in addition to buying government bonds through open market operations.

“In 2013, the RBI had provided a special liquidity support—a three-day repo window—for banks to meet the cash requirements of mutual funds as debt-oriented schemes faced heavy redemption pressure following a surge in bond yields. This had helped offset the squeeze on liquidity following the central bank’s contra measures to defend a falling rupee. Expectations are that a similar arrangement might be on the cards, which will help to soothe nerves and prevent any systemic shocks," said Rao.

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