The monetary policy committee concludes its three-day meeting today. While a majority of economists are still forecasting a status quo in the policy rate, some are expecting the rate hiking cycle to begin in June.
Fourteen of 43 economists polled by Bloomberg expect a 25 basis point hike in the repo rate to 6.25 percent. If a status quo is maintained, economists expect that to be accompanied by a change in stance to ‘withdrawal of accommodation’, suggesting a rate hike is imminent.
Should the MPC vote for a rate hike, it would be the first since January 2014.
A Split MPC?
Many in the markets expect a split verdict from the MPC.
Minutes of the April policy review had shown that RBI Deputy Governor Viral Acharya is likely to vote for a ‘withdrawal of accommodation’ in the June policy. RBI Executive Director Michael Patra already voted for a rate hike in April and is likely to maintain that stance in June. Among the other four MPC members, Chetan Ghate, too, expressed concerns about structural inflation pressures. RBI Governor Urjit Patel said he would wait for more incoming data on inflation.
Since the April meeting, oil prices have risen 12 percent and the rupee has weakened 3 percent. These factors have only added to inflation concerns and could tip the scales in favour of a tighter monetary policy. With growth reviving as expected, committee members may be more comfortable in shifting focus to their primary mandate of inflation control.
Should the MPC find itself equally divided, Governor Urjit Patel can use his casting vote to break the tie.
Interest rates in the markets have already run up significantly over the last year. Between April and June, the 10-year yield has risen by close to 75 basis points. Corporate funding costs have mirrored this increase.
Market rates have risen in anticipation of higher policy rates but also due to a supply-demand mismatch in the bond markets. PSU banks remain reluctant buyers, leading to muted demand for government and corporate bonds at a time when supply remains high.
The RBI tried to calm the markets by reworking foreign investment rules and doing away with ‘residual maturity’ restrictions. However, it imposed limits on how much a single FPI could hold in one security, leading to some fresh selling.
The RBI also announced one round of bond purchases under its open market operations programme. However, the markets are unclear about the regularity with which the RBI intends to buy government bonds from the market. Given that the overnight call money market rate has remained stable, the RBI may stay away from large bond purchases for now.
Against the backdrop of these uncertainties, markets will be closely watching the RBI’s stance on liquidity and its view on imbalances in the bond market.
The Global Backdrop
While domestic macro factors will be the primary input into the monetary policy decision, the global backdrop has become more important in recent months.
Emerging market economies like Argentina, Turkey, Indonesia and Philippines have chosen to use interest rate hikes to defend their currencies at a time of strong portfolio outflows. India, too, has seen outflows with foreign investors selling a net of Rs 29,000 crore across the debt and equity markets so far this year.
In an editorial in the Financial Times earlier this week, RBI Governor Urjit Patel had warned that the unwinding of the U.S. Federal Reserve’s balance sheet along with higher U.S. government borrowings could lead to a drying-up of dollar funding for emerging markets. It could also increase the possibility of a ‘sudden stop’ for the global economic recovery, Patel cautioned.
As such, the RBI may weigh higher rates as a buffer for the currency markets as well. Not everyone believes that the rate defence is effective in India where the stock of portfolio flows remains dominated by equity flows. However, incrementally, about 50 percent of foreign portfolio flows in FY18 were rate sensitive, JPMorgan economist Sajjid Chinoy told BloombergQuint in a recent interview. This could allow higher rates to provide some support to the currency.