Will RBI hike or hold? Experts think it will be a close call this time

While the RBI's policy stance was kept unchanged at neutral in the previous policy review, the inflation forecast was increased to 4.8-4.9 percent for the first half of the current fiscal year, and 4.7 percent for the second half.

However, a lot has changed since then.

Retail inflation accelerated from 4.87 percent in May to 5.0 percent in June. Although lower than expected, it is beyond the central bank's comfort level of 4.0 percent (+/- 2 percent).

This means that if the RBI's expectation of inflation increases to higher than the prevalent inflation levels, we may see another rate hike on Wednesday.

The MPC's core mandate is to maintain inflation at RBI's desired level. However, since the June 6 policy review, three crucial factors impacting inflation have stabilised.

Oil prices have remained largely unchanged at around $74 per barrel, and the Indian rupee has steadied at 68.57 to the dollar.

Bond yields, which were a concern at the time of the June policy, have also moved downwards to around 7.80 percent from over 8 percent earlier.

A rate hike would push yields up again, which will in turn put pressure on the rupee and treasury portfolios of companies.

Risks to inflation

Core inflation, which excludes food and fuel, has been edging up every passing month and is now at a troublesome 6.4 percent.

The increase in minimum support prices (MSP) on 14 kharif crops to 50 percent more than the cost incurred by farmers to grow the crops, is the biggest such hike in the past five years.

Also, the monsoon is projected to be normal this year.

"We are expecting a rate hike as core inflation is high, demand exists and there are risks to inflation from food and weakening of currency even as oil prices are stable," said Dharmakirti Joshi, Chief Economist at Crisil.

Kotak Securities, Emkay Global and Standard Chartered Bank expect a pre-emptive rate hike in the August policy, while Bank of America Merrill Lynch and Care Ratings expect the central bank to maintain status quo.

Uncertain growth

If RBI were to keep rates unchanged, Joshi said, the members of the MPC may wait for more data to take a call, and may put off taking a decision to  when they meet again in October.

There are mixed signals on the growth front. Trade is not doing well, industrial productivity is down and the fourth quarter was a slow one for the services sector, except for government services.

RBI has projected India's GDP to grow 7.4 percent in FY19.

The central bank's policy stance is likely to remain 'neutral', so it has the flexibility to respond in the future without being bound to hike rates. The RBI will also continue to voice concerns over inflation.

Real rates v/s inflation

In August 2017, RBI Deputy Governor Viral Acharya indicated that the MPC's preferred level for real rates (repo rate adjusted for projected inflation) is around 175 basis points.

But based on the MPC's annual CPI inflation projection of 4.65 percent, real rates today are close to 160 bps, which is much lower than India's peers like Indonesia, Brazil and China.

Global factors

The Bank of Japan on Tuesday voted 7-2 to keep a key short-term interest rate at minus 0.1 percent, while the US central bank is expected to keep its rates unchanged on Wednesday.

However, emerging markets like Indonesia, the Philippines, Turkey and Argentina have hiked policy rates aggressively in the recent past.