The Monetary Policy Committee (MPC) is likely to unanimously vote to up the policy repo rate by 50 basis points (bps) in its forthcoming meeting to rein in the above target inflation and address concerns around weakening of the currency.

If the MPC votes for a 50 bps hike in the repo rate (the interest rate at which banks borrow funds from RBI to overcome short-term liquidity mismatches) on September 30, it would be the third time on the trot that it would have done so. Currently, the repo rate is at 5.40 per cent.

As the retail inflation, which rose from 6.70 per cent in July to 7 per cent in August, is ruling above the upper tolerance level of 6 per cent, and the Indian currency, which breached 81 to the Dollar mark twice last week, is depreciating, there may be a need for a 50 bps repo rate hike.

Economic growth

However, economic growth may require support by way of a pause or a milder repo rate hike due to the dip in the industrial production growth rate to a four month low of 2.4 per cent in July against 12.7 per cent in June.

The Rupee has weakened about 2.21 per cent (or by ₹1.755 per Dollar) between MPC’s last meeting (August 5 close: 79.235) and till date (last Friday’s close 80.99) even as the US Fed delivered jumbo sized hikes of 75 basis points each in its last three meetings to stamp out decades of high inflation.

Inflationary effects

Weakening currency can produce inflationary effects in the economy as India is a net importer.

Madan Sabnavis, Chief Economist, Bank of Baroda, observed that inflation remains high at around 7 per cent and is unlikely to come down any time soon.

“This means that a rate hike is given…While a hike of 25-35 bps would have signaled that the RBI is confident that the worst of inflation is over, the recent developments in the forex market could prompt a higher quantum of 50 bps to stay on track with other markets so as to retain investor interest,” he said.

Change in stance

Sabnavis expects RBI to make some announcements on liquidity since after a long time it has moved into a deficit.

“This is exerting pressure on short term yields and sort of inverting the curve. A calendar on OMO (open market operation) is what could be expected along with variable repo auctions. As we expect the stance to change to neutral (from calibrated withdrawal of accommodation), reintroduction of GSAPs (Government Securities Acquisition Plan) may be skipped to avoid sending contrary signals,” he said. 

Barclays’ Chief India Economist Rahul Bajoria expects the MPC to unanimously deliver another 50 bps rate hike during upcoming policy review meeting, and change its stance to neutral.

“While there are early signs of stabilising growth momentum, above-target inflation and an evolving external backdrop leave little scope for the RBI to pause its policy tightening cycle,” he said in a note.

Bajoria noted that as the MPC sits to deliberate its September 30 policy decision, it will be taking cues from the synchronised global monetary-tightening cycle.

“Either reluctantly or by their own volition, Emerging market central banks are syncing up with the Fed in tightening monetary conditions amid weaker exchange rates,” he said.

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