The Reserve Bank of India (RBI) is likely to maintain its hawkish stance and increase the repo rate by 25 basis points (bps) in the upcoming monetary policy review on October 29, according to Indranil Pan, Chief Economist, Kotak Mahindra Bank.
Repo rate is the rate at which banks borrow short-term funds from RBI.
“We expect 25 bps repo rate hike on October 29… Even as growth remains on the downside, inflationary pressures (especially retail inflation) are likely to be priority for the RBI,” Pan said in a report.
According to the report, RBI’s policy has to necessarily target three key areas – 1. Support growth and maintain an environment whereby productive sectors are not hurt, 2. Maintain (and possibly reduce) inflation expectations even as the pressures arise from the food inflation front, and 3. Provide an environment for pick-up in financial savings.
“However, in the current environment achieving all the three broad objectives is likely to be difficult. The current conditions in the global markets imply that the RBI would need to maintain its priority of macroeconomic stability, implying that policy rates need to be geared towards lower inflation.
“To that effect, for the near term, we expect the RBI to hike repo rate by a further 25 bps. This will likely be accompanied by a 25 bps cut in MSF rate if the external sector worries remain subdued, thereby closing the corridor to 100 bps (between repo and MSF),” the report said.
The RBI had hiked MSF rate by 200 bps to 10.25 per cent closing the corridor to 300 bps in July in order to stabilise the sharply depreciating rupee.
Food inflation - A dominant concern
Food inflation too masked disinflationary trends. Inflation metrics continue to be on the adverse side and above expectations in September with the CPI inflation at 9.84 per cent and WPI inflation at 6.46 per cent. This risks unhinging of inflation expectations and is likely to remain a dominant concern for policymakers.
September WPI inflation (like in August) continued to surprise on the upside at 6.46 per cent. This was led again by high food inflation (18.4 per cent) with vegetables inflation of 89.4 per cent led by onion prices even as on a month-on-month basis it came down by 1.9 per cent.
Reduced pricing power, weak demand, chances of lower food inflation over the next few months, better currency and weaker wage growth have been forming expectations of disinflationary trends in the economy.
However, one needs to maintain caution on upside pressures on the food front due to supply-side issues, something that the RBI will not be able to ignore. Hence, the stance of the RBI will necessarily remain hawkish.
“We expect end-FY2014 WPI inflation at 7.3 per cent and CPI inflation at 9.2 per cent. This will be contingent on the degree of softening of food prices in December and the quantum of fuel (diesel) price changes,” the report said.