Banking Central | Another rate hike coming this week

Shaktikanta Das (FIle image)

Predicting the outcome of the Reserve Bank of India’s three-day monetary policy committee (MPC) meeting, which begins on August 3, is a no-brainer this time. Governor Shaktikanta Das has already talked about rate hikes to combat inflation.

This time, the bet is a 25-35 basis points (bps) hike. One bps is one-hundredth of a percentage point. It makes sense, considering that the rate-setting panel’s biggest foe now is high inflation. Some easing in the recent prints doesn’t take away the fact that inflation remains far above the MPC’s comfort zone.

A 35 bps hike will take the repo rate, the rate at which the RBI lends short-term funds to banks, back to 5.25 percent to pre-pandemic levels and that is where the rates are likely to settle in the current cycle unless inflation further surprises on the upside.

The MPC has already hiked the rates by 90 basis points in the current rate cycle, in line with the plan to gradually withdraw from the so-called accommodative stance.

Three key risk factors will prompt the MPC to remain on guard against inflation.

One, the retail inflation remains too high. While there was a drop in May, shop-end prices have now spent 32 consecutive months above the medium-term target of 4 percent and five straight months above the 6 percent upper-bound of the RBI’s 2-6 percent tolerance range.

Two, external factors continue to weigh on India and other emerging markets. Global rise in interest rates, high commodity prices and the Russia-Ukraine war, which has set off a cycle of events with far-reaching consequences for the world’s economic health, to name a few.

Third, the MPC can't ignore a weak rupee as well. A weak Indian currency adds to the inflation woes and nullifies the benefits of some easing in global commodity prices. The currency is under pressure despite the steps taken by the RBI to draw foreign fund inflows.

A combination of factors, including high global commodity prices, foreign fund flows and the central bank's inability to further intervene in the market due to falling forex reserves, has worked against the Indian currency.

The rupee has fallen around 7 percent against the dollar, so far, in 2022.

So, what happens if the MPC on August 5 announces another rate hike? Another rate hike may not significantly lead to further transmission in bank rates from what we have seen in the recent past. Systemic liquidity has come down to a significant extent in recent weeks—much sooner than expected.

A 25-35 bps hike will reaffirm the RBI’s inflation-fighting course and that will a no surprise.

(Banking Central is a weekly column that keeps a close watch and connects the dots about the sector's most important events for readers.)