Weak rupee may prompt RBI to raise repo rate

Inflationary concerns due to costlier oil imports and a weakening rupee could prompt the Reserve Bank of India to raise the repo rate by 25 basis points (bps) in the upcoming monetary policy review, which is scheduled to be announced on October 5.

Also, with a rate hike, the RBI could attempt to stem the increasing foreign exchange outflows — foreign portfolio investors are seen to prefer safe-haven investment in the US in the backdrop of that country’s escalating trade war with China, and given the Federal Reserve’s latest rate hike.

Third successive hike?

A widening current account deficit, which again negatively impacts the rupee, will also weigh on the members of the monetary policy committee (MPC) when they vote on the policy rate. Market experts feel that if the rate is hiked — for the third consecutive instance — it could lead to the central bank changing its ‘neutral’ policy stance.

Repo rate is the interest rate at which the RBI provides liquidity to banks to help them overcome short-term liquidity mismatches. This rate, which currently stands at 6.50 per cent, has been upped twice in the previous two policy reviews, by 25 bps on each occasion.

Soumya Kanti Ghosh, Group Chief Economic Advisor, SBI, said that as the case (rupee depreciating against the dollar) is similar to the 2013 currency crisis, the RBI should raise the policy repo rate by at least 25 bps.

“We rule out a hike of 50 bps, as it may spook the market. However, there is an outside probability of change in the neutral stance too, as three successive rate hikes with a neutral stance could contradict the RBI message,” he said.

Retail inflation

While retail inflation or Consumer Price Inflation (CPI) — it stood at a 10-month low of 3.69 per cent for August compared to 4.17 per cent the previous month — and GDP growth — in the first three months (April-June) of the current fiscal it measured a robust 8.2 per cent — both warrant a hold in the policy rate, experts say the volatility in the rupee has become a cause for concern, requiring a policy response.

Aditya Narain, Head of Research, Edelweiss Securities, said in a report that the RBI is likely to raise the policy rate by 25 bps.

“Policy-makers face a tough macro-economic backdrop. While softer-than-expected inflation calls for a pause, persistent pressure on the rupee perhaps warrants a rate hike (much in line with other emerging market central banks).

“At the same time, the recent turmoil in domestic wholesale funding markets and tightening liquidity make a case for liquidity easing measures. Not all objectives are fully aligned, if not inconsistent. Yet, at this stage, we think the RBI is likely to prioritise external stability and would thus raise the interest rate.”

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