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RBI finds itself between a rock & a hard place this rate review

By DK Aggarwal

Anecdotes such as better-than-expected GDP d..

By DK Aggarwal

Anecdotes such as better-than-expected GDP data and rising crude oil prices, which have posed additional upside risks to headline inflation, are all pointing towards a more hawkish tone from the Reserve Bank of India (RBI) in its upcoming meeting, which is scheduled on June 4-6.

The dramatic shift in expectations was driven by high oil prices and rising bond yields. To note, Indias economy expanded 7.7 per cent, its fastest pace since demonetisation, as government spending continued to drive the recovery in the fourth quarter of 2017-18 compared with a 6.1 per cent growth in the same period last year.

Another data showed build-up of inflationary pressure due to a surge in global oil prices. Since last August 2017, RBI hasnt tinkered with rates. However, it cut inflation projections in the last meeting, raising expectations that borrowing costs would remain on hold.

The deviation between RBIs April policy meeting and the minutes that were hawkish suggests the argument of rising inflation may prompt RBI to hike policy rates going forward.

Even the minutes of April meeting showed that two of the six MPC members have already decided to vote in favour of a 25 basis points rate hike. The deputy governor in charge of monetary policy, Viral Acharya, has clarified that he would vote for a withdrawal in monetary accommodation in June.

Meanwhile, some banks such as State Bank of India (SBI), HDFC and Axis Bank – to name a few – have already started raising interest rates. It is expected that RBI will keep its policy rates unchanged in the forthcoming monetary policy review as apart from rising crude oil prices, RBI will closely watch other developments such as announcements of hikes in minimum support prices (MSP) for the summer (kharif) crops, monsoon outcome and more inflation data before going on a rate hiking cycle.

Besides, RBI will also closely watch the risk of fiscal slippages in the runup to the 2019 general elections, which is likely to add further pressure on the rupee.

The recent weakness seen in the Indian currency may urge RBI to tighten its stance, taking cues from emerging markets central banks. However, the other side of the story is that if RBI goes for a rate hike, it would accelerate the ongoing rise in bank deposit and lending rates and at the same time obstruct Indias growth recovery, as it has the potential to dent credit growth in the short term.

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