RBI Monetary Policy preview: Balancing act necessary, says EdelweissReserve Bank of India (RBI) has started its bi-monthly monetary policy committee (MPC) meeting today, 3 October, and is expected to announce the decisions on Friday, Oct 5. This is the fourth MPC meeting of the fiscal year 2018-2019. RBI Governor Urjit Patel is the chair of the six-member MPC committee. The street is expecting a hike in the benchmark repo rates by 25 basis points. This financial year, RBI has raised the repo rates twice already – in its June and August MPC meetings.

The repo rate is the rate at which the RBI lends to other banks in India. (The Reverse Repo rate is the rate at which the RBI borrows from other banks in India.) RBI rate hikes mean it will cause other banks to increase interest rates because banks’ borrowing costs will also increase. This will result in higher EMIs for you as a consumer. This will have a trickle down effect on the economy as the demand will reduce, and in turn, the economic growth will slow down. Right now the priority for the RBI is to check inflation while also making sure rupee does not depreciate further. Some experts feel this requires a rate hike, while some advise a neutral stance (no hike).

Here is the complete text of a note issued by financial services firm Edelweiss on what stance the upcoming RBI monetary policy should take:

RBI Monetary Policy preview: Balancing act necessary, says Edelweiss

The RBI is likely to raise the policy repo rate by 25bps from 6.5% to 6.75% in its upcoming monetary policy review on 5th October. The central bank will have to balance multiple objectives in the current meeting. While inflation has been decelerating in the past two months, some upside risks are still abound. INR continues on its falling trajectory due to declining US dollar liquidity in emerging markets. Liquidity stress in the corporate bond and money markets, triggered by the IL&FS defaults, are leading to market-wide woes in the economy.

While raising rates would counter the declining INR trend and the deteriorating BOP position, it would lead to further liquidity stress in the market. RBI has already done OMO purchases of INR 51k crore this fiscal and has announced plans to infuse further liquidity of INR 36k crore in October, in order to counter the liquidity deficit in the market and ease the sky high bond yields. RBI will have to balance the two misaligned objectives.

External and internal risks

CPI inflation decelerated to 3.7% Y-o-Y in August’18 from 4.2% Y-o-Y in July’18, while core CPI inflation (ex. Food and fuel) also eased slightly to 5.8% Y-o-Y from 6.2% Y-o-Y in July. The easing headline inflation scenario mainly on the back of benign food inflation, gives RBI some comfort. However, upside risks such as MSP hikes, continuously rising international crude oil prices and pre-election spending by the government still persist.

On the external front, rate tightening by the US Fed which further raised benchmark rates by 25bps in the last FOMC meeting coupled with a pro-cyclical US fiscal policy are squeezing dollar liquidity from emerging markets including India. Along with this, the continuously rising international crude oil prices with Brent crude crossing USD 82/barrel are putting enormous pressure on India’s current account. CAD is expected to reach 2.9% of GDP in FY19. Such a deteriorating BOP position and INR depreciation requires urgent consideration from the MPC and may warrant a rate hike.

Liquidity stress in Indian markets

Recent turmoil in the short term debt markets and rising corporate bond yields, leading to a liquidity deficit, are causing market-wide jitters in India. Such liquidity issues have the potential to increase the cost of capital of Indian corporates and cut short the recovering economic growth. RBI has had to intervene through OMO purchases and easing of some easing of LCR norms in order to counter such woes. The government has also intervened in this front and have decided to cut their market borrowing target by INR 70k crore for this fiscal. Such liquidity injection may stabilize the short term woes but at the cost of undermining RBI’s external position and monetary tightening objectives.

Outlook

We believe that the MPC would stick to their stated objective of monetary tightening in order to remain credible and hike policy repo rate by 25bps. Liquidity injection measures shall continue in order to address the short term liquidity issues, however, RBI will have to strike a careful balance between the contrasting objectives. Main considerations going ahead would be government’s measures in order to address the currency as well as liquidity pressures, rising crude prices, trade tensions and the international monetary tightening scenario.