After raising its key policy rate — the Repo rate by 25 basis points in June, it could well be a close call this time around for the Monetary Policy Committee (MPC) of the Reserve Bank of India in the bi-monthly policy review on August 1 with opinion divided over whether to raise interest rates or to leave it unchanged.
A section of the financial markets and analysts say that there may not be much urgency in delivering back to back rate hikes when the policy stance is still neutral. Given the lack of clarity regarding inflationary and fiscal risks, the RBI is likely to persist with the neutral stance of the monetary policy to signal that the timing and magnitude of upcoming rate hikes would be data dependent, analysts said.
If the RBI stance is changed to withdrawal of accommodation, it may be perceived as a signal of a series of impending rate hikes. This could lead to a rise in bond yields, while contributing to a pullback of the rupee which is now showing volatile movements. With the stock markets moving Northwards, foreign investors who sold around Rs 60000 crore in the April to June, have made marginal purchases.
However, others, including rating firm ICRA say: with mixed cues regarding the extent of inflationary and fiscal risks, and the momentum of economic growth, the MPC would adopt a cautious stance and increase the repo rate to 6.50 per cent in the August review. The rise in core inflation is the real worry of policymakers.
Lakshmi Iyer, Chief Investment Officer, Kotak Mutual Fund, said: “The August MPC decision could be a close call. Consumer inflation for June was lower than expected. Crude oil prices have been largely range-bound. There also seems uncertainty on how the global trade war could potentially unfold. In such a scenario, the MPC could afford to do a ‘wait and watch’ at this juncture and consider more data points before a rate action.” From the market perspective, bond yields already seem to have discounted another rate hike and hence yields are at elevated levels.
The relief is that the August policy comes with a breather on the inflation front as the expected inch up to inflation in June has not materialised with a print of 5 per cent against expectation of 5.4 per cent. Monsoon also recovered sharply in July and international oil prices have corrected by 5 per cent since last policy in June and the currency is now moving in a narrow range.
The case against status quo could be on two counts. First, higher core inflation seems to have peaked at 6 per cent as per the base case scenario. Second, the sharp hike in MSP prices of close to 15 per cent against last four year average of 4 per cent could impact inflation. As the average inflation for FY 2019 could be 4.75 per cent against 3.8 per cent last fiscal, there is room for 25 bps hike in rates either pre-emptively now or in October, beyond that oil prices should drive the reaction function of the policy makers, said Kunal Shah, Debt Fund Manager, Kotak Life Insurance.
Naresh Takkar, Managing Director and Group CEO, ICRA, said, “while the cuts in rates of the GST on various items may modestly subdue inflation, they would add to fiscal concerns. Moreover, the uptick in the core-CPI inflation in June 2018 and the risks associated with the trend of expenditure announcements by state governments, suggest that the MPC may opt for a pre-emptive rate hike in August 2018.”
“Depending on the impact of inflationary and fiscal risks on the inflation outlook, the MPC may raise the repo rate by 25-50 bps in the last three-quarters of FY2019. However, it may retain the neutral stance of the monetary policy instead of a shift to withdrawal of accommodation, to signal that the timing and extent of future rate hikes would remain data dependent,” Takkar said.
According to Crisil, though food inflation decelerated, what took the number higher was firming up of fuel and core inflation. The MPC had hiked its policy rate by 25 bps in June envisaging exactly such pressure. Crisil said sustained rise in core inflation would worry the MPC and may require one more rate hike down the road. Core inflation is becoming broad-based with almost all categories such as health, recreation and amusement and education showing a rising trend.