Rising bond yields and projection of possible spike in inflation are key concerns for policymakers globally and RBI policy review could revolve around them.
RBI may also take note of the government's revised fiscal targets and may turn hawkish. It is expected to set the ball rolling for a rate hike in the next policy review, even though it is widely expected to maintain status quo for now.
Here are five things to watch in the policy announcement:
Outlook on government fiscal slippage
DBS economist Radhika Rao in a noted said the RBI is likely to factor in the projected fiscal slippage. The combination of fiscal challenges and rising oil prices make RBI's policy path a tricky one this year, she said.
"Growth has largely bottomed out, but India has yet to benefit from the synchronised pick-up in global demand. In this light, we expect the monetary policy committee to turn hawkish, but not enough for the balance to tip towards a rate hike," she said.
The government has revised its FY18 fiscal deficit target to 3.5 per cent of GDP from targeted 3.2 per cent. It also revised its FY19 target to 3.3 per cent from 3 per cent target envisaged in the medium-term fiscal roadmap.
MPC may increase inflation, lower GVA targets
RBI may also project a higher inflation estimates and revise down its GVA (Gross Value-added) growth forecast for FY18, Rao said.
"For now, we are retaining our base case for an unchanged policy bias in 2018 based on our assumption that inflation will moderate towards 4 per cent in H2 2018. Even so, we acknowledge that the odds for rate hikes to be brought forward to H2 would rise if inflation proves sticky around 5 per cent from the MSPs and persistently higher oil prices," she said.
Watch commentary on MSP, oil price risks
Nomura India expects RBI to flag risk of higher MSP and slower fiscal consolidation – as a medium-term risk to inflation.
"If the MSP increases are much larger, they could feed into higher inflation and increase the chances of a tighter monetary policy. Oil prices are another risk," the brokerage said.
RBI may try to soothe bond market
Macro risks to the bond (G-Sec) market are overdone with RBI stepping up durable liquidity/reserve money injection to $27 billion from barely $4 billion in end-November, said BofA-ML. "We expect RBI/MoF to come out with confidence building measures (CBMs) – eg, FPI limit hike – to persuade investors to buy G-secs that are increasingly seen as a falling knife. In sum, open mouth operations will be as important as open market operations (OMO) on Wednesday," it said.
View on global tightening
In the past two months, central banks in the developed world have turned a bit more hawkish. While the Fed already on the path of raising interest rates and shrinking its balance sheet, ECB too seems to turning less accommodative, embarking on a tapering programme and stating that Euro area growth remains strong, said Edelweiss Securities.
"As a result, global interest rates have risen. This curtails RBI's elbow room to turn more accommodative," it said.