A vendor holds an Indian twenty-rupee banknote while selling artificial garlands at Dashasumedh ghat on the banks of the Ganges river in Varanasi, Uttar Pradesh. (Photographer: Dhiraj Singh/Bloomberg)

With Inflation Punching Above Its Weight, HSBC Now Sees Two Rates Hikes In 2018

A rise in core inflation. Higher oil prices. A weaker rupee. A pick up in growth. The list of factors giving India’s Monetary Policy Committee (MPC) enough reason to raise rates is expanding.

Taking note of the all these factors, HSBC Global Research is now forecasting two rate hikes of 25 basis points each in 2018. It reverses its call from a ‘prolonged pause’ in rates and now sees consecutive rate hikes in August and December. A rate hike at the upcoming June policy can not be ruled out, HSBC economist Pranjul Bhandari wrote in a report published on Tuesday, but added that its base case remains for rate hikes to begin in August.

The RBI’s repo rate is currently at 6 percent.

The change in call comes a day after retail and wholesale inflation surprised to the upside. In April, retail inflation stood at 4.58 percent, showed data released by the government. But it wasn’t the headline inflation that has perturbed economists. Core inflation, which strips out volatile food and energy prices, rose to a four year high of 5.9 percent.

HSBC expects inflation to average 5.1 percent in FY19 compared to underlying inflation of 4.1 percent last year. The factors that will contribute to the increase in inflation include:

  • Higher oil prices: Every $10/barrel adds 30 basis points to CPI
  • Weaker rupee: A near 5 percent depreciation will add 20 basis points to CPI
  • Higher Minimum Support Prices (MSPs) and re-monetization: To raise the average of the year inflation print by close to 30 basis points
  • Closing output gap: Mere normalisation in core prices will add 15 basis points
Perhaps no one reason alone warrants rate hikes. However, a sum of many reasons – (1) Fed rate hikes and tighter US dollar liquidity, (2) higher oil prices stoking inflation and current account deficit, (3) cyclical growth recovery and closing output gap, and (4) higher MSPs alongside re-monetization – does. Looking through all of this, we believe that the RBI has enough reasons to raise rates by 50 basis points in this cycle.
Pranjul Bhandari, Chief Economist - India, HSBC Global Research

Bhandari adds that should the MPC feel the need to act, it may choose to do so sooner rather than later. The time lag in the impact of monetary policy, continuing monetary policy normalisation in the U.S. and impending elections in 2019 could mean that rates hikes beginning June or August cannot be ruled out.

“However, the RBI may want to wait a bit longer to get clarity on how the monsoon rains, which can be an important determinant of food prices, progress,” Bhandari wrote.

Sensing that rate hikes are drawing closer, bond markets saw another sell-off on Tuesday. The benchmark 10-year bond yield was trading above 7.85 percent on Tuesday afternoon.

While others are yet to revise their rate calls for the year, they are watchful.

Neelkanth Mishra of Credit Suisse, in a note on Tuesday, wrote that the broad based rise in core inflation ex-fuel is worth watching. Core inflation rose 55 basis points month-on-month and this was the sixth consecutive month of increase, noted Credit Suisse.

The broad-based increase in core is surprising particularly as most categories seem to be trending to 5 percent, implying that even after housing-related inflation moderates (Sep-2018 onwards), core inflation could stay above 4.5 percent.
Neelkanth Mishra, Credit Suisse

Countering concerns of a rate hike, Soumya Kanti Ghosh, chief economist at State Bank of India said there is no data to support the rate hike fears. Ghosh acknowledges that core inflation at near 6 percent is disconcerting but adds that it will peak by about June and fall thereafter.

“Birds of a feather flock together. This aptly summarises the current market sentiments of a probable rate hike by RBI in response to inflation trends. Such fears are unwarranted....” Ghosh wrote in his note on Monday