From the Monetary Policy Committee's last resolution in June to the one scheduled for Friday, Aug. 5, the environment has changed. Inflation, the central bank said, has peaked, global markets are worrying about an impending recession and liquidity has tightened considerably.
While the turn in the environment is palpable, it may not be enough for the MPC to pause its rate hiking cycle. The committee, however, may reduce the quantum of rate hikes and try to dial back expectations of future rate hikes.
After 90 basis points in repo rate hikes so far this financial year, the benchmark rate now stands at 4.9%.
Of the 19 economists polled by Bloomberg, 10 expect a 50-basis-point rate hike to 5.4%, while six a 35-basis-points hike to 5.25%. Only two economists expect a hike of 25 basis points to 5.15%, while one sees a hike of 40 basis points to 5.3%.
A rate hike at the upcoming meeting could make this the fastest increase in the benchmark repo rate over the past decade.
Still, rates may peak sooner than earlier expected.
The growth recovery has so far been resilient despite intensifying headwinds, Rahul Bajoria, chief economist at Barclays, said. A weakening global outlook, tightening domestic financial conditions and elevated input costs could weigh on the recovery, he cautioned.
Any emerging concerns on growth, along with the moderating inflation trajectory means that the RBI will move closer to its desired level of real rates soon, which should also contribute to a lower terminal rate of 5.75% for this cycle, according to Bajoria, who forecasts the MPC to hike by 35 basis points on Friday.
Repo Rate: The Steep Climb Up
In the base case, the RBI MPC is expected to hike policy repo rate by 35 basis points, taking it to 5.25%—higher than the pre-pandemic level—with stance change to calibrated tightening from withdrawal of accommodation, according to a note by BofA Securities. The possibility of an aggressive 50 basis points and a measured 25 basis points hike cannot be ruled out either, it said.
Upasna Bhardwaj and Suvodeep Rakshit, economists at Kotak Institutional Equities, forecast a steeper hike because of external sector concerns even amidst a gradual fall in inflation.
"The RBI will hike repo rate by 50 basis points to acknowledge elevated but gradually falling inflation, being in sync with global monetary policy, addressing external sector pressures by managing interest rate differentials, and continuing to frontload the rate hikes." Arguably, the quantum of hike is finely balanced within the 35-50 basis points range, they said in a research note published on July 29, 2022.
CPI Inflation: Small Wins
The Consumer Price Index inflation fell to 7.01% in June from 7.04% in May and 7.79% in April, easing for the third straight month. Inflation in food and beverages, and core inflation, excluding food and fuel, also eased. Still, it remains above the 4 (+/-2)% target for the sixth straight month.
Even as the central bank is convinced that inflation is now on the "back foot", it is forecasted to breach its upper target this quarter too. Breach of the target for three consecutive quarters requires the RBI to write a letter explaining the breach to the government.
The RBI forecasts inflation at 7.4% in Q2 FY23.
Liquidity: Fast Falling
While the RBI may need to keep hiking policy rates, it no longer needs to take steps to suck out excess liquidity. Banking liquidity has tightened, falling to near Rs 1.5 lakh crore in recent weeks. One reason for this is the RBI's intervention the foreign exchange market. The selling of dollars is draining liquidity, Saugata Bhattacharya, chief economist at Axis bank, said.
Latent liquidity in the system still remains very high because of the government cash balance amid muted government spending, he said.
Rupee: On A Slippery Slope
While deciding on its next moves, the central bank will be watching the rupee closely. The Indian currency has depreciated by nearly 3% against the dollar since the MPC met in June and by about 6% since Russia's invasion of Ukraine.
While the magnitude of rupee depreciation has been well managed by the RBI through multi-pronged forex intervention measures, interest rate hikes in sync with global peers would help ease some pressure off the currency without further deterioration in the external sector vulnerability matrix, economists at Kotak said.
According to SBI Economic Research's estimates, FY23 will be a challenging year for the rupee, with the current account deficit estimated to breach the 3% mark and reach 3.2% of the GDP.
Brent Oil: Above Comfort Level
Crude has eased since June but remains elevated. The price of crude oil is expected to be in range of $100-110 per barrel for the next two months though recent softening stance of the European Union on oil and food grains from Russia augurs well for price collapse, according to Soumyakanti Ghosh, chief economist at SBI.
The ensuing slowdown in the EU, too, will soon set in motion the correction of high prices, he said.
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