MPC’s difficult balancing act
The Indian rupee will likely remain exposed to the ebbs and flows of global tides in the near term
A 25 basis points repo rate hike in the October monetary policy committee (MPC) meeting is our baseline expectation. Amid higher oil prices and a rapid weakening of the Indian rupee, we expect the MPC to tilt towards greater caution with the objective of containing aggregate demand as well as pushing real interest rates higher. As regards their stance on liquidity, the committee seems to be stuck between the proverbial rock and the hard place. On the one hand, the Indian rupee has fallen rapidly to beyond 72.50 against the US dollar from less than 68.50 at the time of the previous MPC meeting in early August. Traditional monetary theory would suggest RBI to keep rupee liquidity in check to contain potential speculative pressures against the domestic currency. On the other hand, the more recent bout of sharp volatility in Indian equity market, specifically for segments of financial companies facing liquidity stress, would demand the central bank to offer greater support to money market liquidity in the near term.