What to Expect from RBI’s policy meet this week

The last interest rate hike by the Reserve Bank of India (RBI), in the current rate hike cycle, happened on 8 February. The next meeting is round the corner, on 6 October. It is likely that RBI would pause at the current level for some time. There is also a faint expectation that RBI may hike the rate one last time, taking the repo rate from 6.5% to 6.75%. Here are two factors that will influence the decision by RBI.

Inflation spike: Consumer price inflation (CPI) hit a high of 7.44% in July. This was higher than RBI’s tolerance band of 6 %, higher than what the market was expecting, and a leap from June’s 4.87%. This had more to do with supply-oriented issues. It was largely due to vegetable prices, which shot up due to an erratic monsoon and other reasons. Till 28 September, rainfall was 6% lower than the long-period average. We have already seen that tomato prices have eased from its peak of more than 100. The government has taken measures on grain and vegetable supplies, with export restrictions, supply at controlled prices, etc. Inflation for August has eased to 6.83%.

In the policy review meeting on 10 August, RBI revised the inflation projections upward. For the financial year 2023-24, the CPI projection was revised from 5.1% in June to 5.4%. The revision was steepest for the July-September quarter. From 5.2% earlier, projection for the quarter was raised by one percentage point to 6.2%. Inflation for July and August being 7.44% and 6.83%, respectively, there is a possibility that CPI for the July-September quarter may overshoot RBI’s projection of 6.2%. Crude oil prices have moved up to around $94 a barrel. However, petrol and diesel rices have not been increased for some time, which is a saving grace in the context of inflation.

Spike in US treasury yields: US government bond yields have moved up. The 10-year treasury is at 4.65%. The dollar has strengthened: Dollar Index (DXY), the global measure, has moved up from 100 to more than 106. Expectations of another rate hike by the US Federal Reserve are high. This has been driven by positive GDP growth, buoyant labour market data and the Fed’s communication after it met on 20 September. The probability of a rate hike in US Fed meetings is imputed from levels of US Fed Funds Futures. For the forthcoming Fed meeting on 1 November, the market is assigning a 22% probability of a rate hike. It is 42% for the next meeting on 13 December.

There is a perception in some sections of the market that a rate hike by the US has to be followed here by RBI. The logic given is that if the interest rate differential and sovereign bond yield differential between US and India is low, foreign investments may flow out. If the dollar is strong, we have to hike interest rates to support the rupee. However, this logic is not right. Foreign portfolio investments in Indian sovereign bonds is less than 1% of the outstanding stock. There is no need to modulate our interest rate policy as per external suitability. Post the announcement of inclusion of our government bonds in JP Morgan Emerging Markets index from June 2024, FPI inflows in debt of more than $25 billion is expected. On currency, while the level of DXY is relevant and influences the level of the rupee, our currency has been reasonably stable. While the DXY strengthened from 100 to more than 106, the rupee has just breached 83.

In the context of the forthcoming RBI policy review meeting, it is best to keep fingers crossed that interest rates are maintained—especially if you have availed of a home loan or any other floating-rate loan, . From the investment perspective, in the event of an unlikely repo rate hike, there will be some immediate reaction in the market. However, thereafter, the market will look at it as the last in the rate hike cycle and move on. As and when inflation eases, the case for interest rate cuts will build up, likely April 2024 onwards.

Joydeep Sen is a corporate trainer (financial markets) and author.