So, will the RBI
raise interest rates in its upcoming monetary policy review tomorrow? Here is what top research houses and brokerages expect.
BofA Merrill Lynch
We believe that the RBI
MPC will wait and watch on Wednesday - with a hawkish tone - after its June hike. If the monsoons are normal, it should be on a long hold. If, however, the east does not get sufficient rains, then the RBI
MPC will likely hike 25 bps in October, although release of rice buffer stock will help far more than monetary tightening.
On our part, we would watch for the RBI's open market operations (OMO) plans ($50 billion if FPI flows do not revive) with durable liquidity contracting by about $10 billion to defend Rs 69/USD. We estimate that the RBI will have to sell $20 billion ($14 billion so far) if FPI flows do not turn around. It also remains to be seen if the RBI assures the FX market that NRI bonds (raising $30-35 billion BAMLe) are a policy option. The MoF has already done so.
We pencil in a repo rate
of 25 bps in the August policy. The key reasons to hike are (1) headline inflation
remains well above the 4% mark over the medium term, (2) core inflation
remains sticky and high along with risks of higher input prices being passed on over the next few quarters, (3) announced MSP hikes and the risk of it percolating to food inflation (which also implies the RBI should revise its headline inflation marginally higher for 2HFY19), (4) concerns on INR remain, and (5) growth remains on a stronger footing implying that the output gap is fast closing in and can lead to inflationary pressures in the medium term. Even as we call for a rate hike, the RBI may pause mainly to wait-and-watch if MSP hikes start to percolate to food prices and how the inflationary expectations have evolved over the last quarter.
With RBI rate decisions now being guided by inflation targeting objective, the recent pick-up in inflation momentum will see the central bank hiking repo rate
by another 25 bps on August 1 to 6.50%.
With this, the RBI will move past the level last seen in October 2016 when it had adopted a ‘neutral’ stance, implying that the next rate hike will be the first move towards a ‘tightening’ stance in the current cycle. We now believe that with the sharp rise in both CPI and WPI inflation, RBI may do a cumulative tightening of more than 50 bps during the rest of FY19.
Retail (CPI) inflation continued to harden in June 2018, rising to 5.0% yoy, along with persistent rise in core inflation at 6.4%. WPI inflation is at 5-year high of 5.8% yoy, picking up way beyond CPI inflation due to a sharper rise in commodity inflation.