The Monetary Policy Committee (MPC) of the Reserve Bank of India (RBI) is likely to hold interest rates at its penultimate monetary policy review of the fiscal owing to higher inflation in October and a surge in oil prices.
Interest rates are currently at a seven-year low and experts will be keenly watching the tone of the central bank in terms of its policy guidance and rising inflation.
The MPC, that began its two-day meet on Tuesday, is expected to announce its decision at 2:30 p.m. in Mumbai followed by a press conference 15 minutes later.
Most surveys have projected a majority view of the RBI holding key interest rates. According to a Bloomberg survey, 42 of the 48 economists see the repo rate, or the rate at which banks borrow from the RBI, unchanged at 6 per cent.
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At its previous bi-monthly policy review in October, the RBI had maintained status quo on its repo rate at 6 per cent, citing risks to inflation and uncertainties on the external and fiscal fronts.
It had reduced the repurchase rate by 0.25 percentage points to 6 per cent earlier in August.
Japanese financial services major Nomura said in a report that input cost pressures are marginally higher now, which along with higher food inflation is likely to push retail inflation slightly above the RBI's target of 4 per cent in November and beyond.
"We expect a hawkish hold from the RBI..and policy rates to remain unchanged through 2018," it said.
Economy on the Rebound
After five successive quarters of decline, India’s GDP growth recovered to 6.3 percent in July-September from a year ago. It had clocked 5.7 per cent in the previous quarter, the lowest under the Narendra Modi government, mainly on the twin impact of demonetisation and the rollout of the Goods and Services Tax. Rise in the country’s manufacturing was the major contributor behind this recovery.
However, concerns remain over the recovery remain with capacity utilization still hovering at around 70 per cent, signaling slack demand conditions. Credit remains subdued and a private gauge on Tuesday showed the dominant services sector contracted in November, raising concerns about the pace of recovery.
Goldman Sachs, however, sees the government’s $32 billion bank repaitalisation plan as a game-changer and pegged India’s growth rate at 8 per cent in FY19.
The Inflation Conundrum
While experts arguing for a rate cut say that interest rates adjusted for inflation are higher in India, and that it is acting as an obstacle for India’s economy to realise its true potential, RBI’s expectations of inflation could deter any chance of a rate cut.
Data released in November showed that India's annual rate of inflation based on wholesale prices (wholesale price index) rose to 3.59 per cent in October due to an exponential rise in food prices.
In addition, the consumer price index (CPI), or retail, inflation for October rose to 3.58 per cent from 3.28 per cent in September.
Domestic credit rating agency ICRA said the MPC would leave the repo rate unchanged at six per cent "in a non-unanimous decision in the December 2017 policy review, given the expectation of a further rise in the CPI inflation in the coming months".
In its previous monetary policy review, the central bank had stated that it expects inflation to rise from the then-level of around 3.3 per cent "and range between 4.2-4.6 per cent in the second half of this year".
RBI Governor Urjit Patel had said the MPC remains committed to keeping headline inflation close to four per cent "on a durable basis".
Liquidity Tightening
Experts will also be watching out for the RBI’s guidance on the future tightening of liquidity conditions. Between July and November, the RBI mopped up Rs 900 billion through open market bond sales between July and November, on top of debt sold by federal and state governments.
Excess liquidity with banks is down to around Rs 700 billion from a peak of more than Rs 5 trillion in March, according to the Bloomberg Economics India Banking Liquidity Index. That has led State Bank of India and the Punjab National Bank -- large state-run lenders -- to raise rates on bulk deposits.
Apart from RBI’s liquidity operations, lower government spending, higher currency in circulation during festival season and ahead of state election also contributed to the liquidity tightness. This, along with fears of fiscal slippage, has led to hardening of yields on bonds. Some market participants believe that a rate cut would give some relief as yield would fall and lead to lower borrowing cost.
