Will RBI Surprise D-street with a Rate Hike?

Fri, 24 Feb Pre-Open

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After the notebandi, everyone was expecting a rate cut between 0.25% to 0.50%. The logic was that a rate cut would boost growth as the government's demonetisation affected consumption. However, in the previous two meetings of the Monetary Policy Committee (MPC), the RBI remained status-quo about the repo rate.

In the last MPC meeting, all the members flagged their concerns over the sticky core inflation. RBI's medium-term inflation target is 4%. It should be noted that core inflation has been higher than headline inflation for five straight months now.

Let's look at some important triggers. First, risks from global financial turbulence. Second, rising crude oil prices. Last but not the least, a less-than-normal south-west monsoon. All these triggers could result in higher inflation going forward.

An upswing in economic growth and inflation in advanced economies, especially the US will only prod the US Federal Reserve into hiking the interest rate. The international leading indexes produced by the Economic Cycle Research Institute (ECRI) indicate stronger global growth and inflation prospects for the coming months. The continued cyclical upswing in ECRI's US Future Inflation Gauge (that anticipates US inflation) points to further increases in inflation. Further, the strength in the leading indexes of US economic growth signal higher economic growth. Both these factors may be consistent with multiple Fed rate hikes this year.

In the minutes of the MPC meeting released by the RBI on Wednesday, RBI governor Urjit Patel wrote,

• 'Domestic industrial input and farm costs, including rural wages, have increased in recent months. Inter alia cost push effects of 7th pay commission allowances, and exchange rate volatility arising from possible shifts in risk premia on a full rollout of US macroeconomic policies impart uncertainty to the inflation trajectory going ahead.'

Newly appointed RBI deputy governor Viral Acharya, said:

• 'It is important to guard the Indian macro-economy from global headwinds, and having a reasonably good chance of attaining the 5% target for headline inflation by the end of March 2017, to keep the option open to start getting closer to our long-term target of 4% headline inflation on a durable basis'.

So what will happen in the next meeting of the MPC which is scheduled on April 5 and 6, 2017? With headwinds in the form of a stubborn and rising core inflation, the strong probability of Fed rate hikes, and rising commodity prices, it looks like there is almost no chance of a rate reduction. Maintaining status-quo on the policy rate looks like a strong possibility.

Will the next meeting deliver a rate hike?

Well, that depends. If the factors mentioned above push inflation above the target limit, the RBI could surprise everyone with a possible rate hike.

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