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With an Eye on Faltering Rupee, RBI to Raise Rates Next Week

Slightly over half the respondents said RBI Governor Urjit Patel and the Monetary Policy Committee would deliver a 25 basis point rise to 6.75 percent at the Oct. 5 policy meeting, with one economist calling for a 50 basis point rise.


Updated:September 26, 2018, 10:52 PM IST
With an Eye on Faltering Rupee, RBI to Raise Rates Next Week
Photo used for representation.

Bengaluru: The Reserve Bank of India is likely to raise interest rates in early October, despite relatively tame inflation, to prop up a retreating rupee, according to a Reuters poll of economists who also trimmed their near-term growth forecasts.

In an abrupt change from the previous survey conducted two months ago, which predicted rates would stay on hold until this quarter next year, over two-thirds of 61 economists polled Sept. 19-25 said the RBI would lift the repo rate at least once by the end of 2018.

Slightly over half the respondents said RBI Governor Urjit Patel and the Monetary Policy Committee would deliver a 25 basis point rise to 6.75 percent at the Oct. 5 policy meeting, with one economist calling for a 50 basis point rise.

While in the July poll, only 11 of 56 respondents expected the repo rate to rise to 6.75 percent by the end of this year, the proportion of economists with that view has jumped to 44 of 61, including 17 who expect it to end the year at 7.00 percent.

The predicted rate hike would be the RBI’s third this year, after it lifted borrowing costs in June and August. The U.S. Federal Reserve is forecast to raise rates later on Wednesday - also its third move this year - according to a separate Reuters poll.

For many analysts, the retreating Indian rupee INR, which has tumbled nearly 15 percent since early 2018 and remains the worst-performing major Asian currency, is likely of concern to policymakers.

On Tuesday the rupee, hit recently by growing credit concerns engulfing non-banking financial companies, was trading at 72.68 to the dollar.

“For the RBI, I think it becomes necessary to provide a policy response. The question was only of timing,” said Radhika Rao, economist at DBS in Singapore.

“Some would say it (rate hike) could have come sooner ... it probably would have been a bit more beneficial. But better now than never.”

If the RBI does raise rates, it would be the latest in a series of emerging market central banks that have been pressured into tightening policy in response to a tumbling currency.

Fortunately for the RBI, the economy is doing well. The Indian economy is forecast to expand by an annual rate of more than 7 percent every quarter for the next two years, although slower than the surprise 8.2 percent rate clocked last quarter.

“Although the high growth rate in Q2 might be partly attributed to favorable base effects ... the underlying dynamics of the Indian economy shows that virtually all high-frequency data is flashing green,” said Hugo Erken, senior economist at Rabobank.

While India remains the world’s fastest-growing major economy, economists have slightly trimmed their forecasts for the coming quarters.

Prices of crude oil LCOc1 - the country’s biggest import – have surged by over 20 percent this year.

That in turn has swollen the current account deficit to an average 1.9 percent of GDP in the fiscal year which ended in March from 0.7 percent in the 2016-17 fiscal year.

The deficit is now forecast to widen further to 2.8 percent of GDP in 2018-19, mainly driven by higher fuel prices, which just over half of nearly 50 respondents also said was the biggest risk to economic growth.

The escalating U.S.-China trade war has not had a major impact on India so far but has spurred on a broad sell-off in emerging market assets in recent months.

Still, the sharp fall in the rupee has not stirred much worry about inflation, which was just under 3.7 percent in August, slightly below the RBI’s 4 percent target.

While it is expected to average a touch above the RBI’s target this quarter and next - significantly lower than the predictions in the last poll two months ago, retail inflation is forecast to rise to 5 percent by the middle of 2019.

Economists were almost evenly split on whether a weaker rupee posed the biggest upside risk to inflation, with 26 of 51 respondents saying it was.

But even if the RBI hikes on Oct. 5 and follows up next year as expected, it will struggle to keep up with the projected pace of U.S. Federal Reserve rate hikes.

“The RBI will have to do more, though that looks unlikely on the grounds of on-target inflation and stress in the financial sector,” noted Prakash Sakpal, Asia economist at ING.

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