RBI MPC meet: Question not whether to raise borrowing costs but by how much

With Wednesday's Monetary Policy Committee (MPC) decision following May's surprise 40 basis-point off-cycle hike, expectations have narrowed down to the size of increase to tame inflation

As India’s monetary policy makers huddle to find ways to tame inflation, the question for them is not whether to raise borrowing costs, but by how much. 
 

The six-member Monetary Policy Committee will probably raise the benchmark interest rate by 40 basis points to 4.8% on Wednesday, according to the median in a Bloomberg survey of 37 economists. As of Monday, the poll returned what is easily the most varied number of predictions for hikes, ranging from 25 basis points to 75 basis points.

With Wednesday’s policy decision following May’s surprise 40 basis-point off-cycle hike, expectations have narrowed down to the size of increase to tame inflation that’s been running above the central bank’s 2%-6% target band since the beginning of this year. Wholesale prices have gained at the fastest pace in over three decades, adding pressure on businesses to pass on high costs to consumers.

“Given the elevated inflation trajectory, RBI will have to front-load rate hikes,” said Kaushik Das, chief India economist at Deutsche Bank AG. A decisive action at this juncture will go a long way toward containing inflation, he added. 

Here’s what to watch for in Governor Shaktikanta Das’s speech after the MPC meeting at 10 a.m. in Mumbai:

Forecast Revision

Analysts will be keenly watching for the central bank’s take on the inflation trajectory, especially after Prime Minister Narendra Modi’s government announced fiscal steps in tandem with monetary efforts to tame prices.

Economists at Barclays Plc and Citigroup Inc. see the RBI raising its average inflation forecast for the year ending March to above 6% from 5.7% seen previously.

The government’s $26 billion fiscal package aimed at easing price pressures by lowering some levies on retail fuels to imports may not provide any immediate reprieve to the inflation-targeting RBI, said Rahul Bajoria, an economist at Barclays.

While inflation worries may keep the RBI focused on prices, near term growth impulses remain largely stable, according to Nomura Holdings Inc. economists Sonal Varma and Aurodeep Nandi. They do not expect a “material downgrade” of growth forecasts in the policy.

Terminal Rate
 

The forecasts would also act as an indication of how much rates can rise in the current cycle, with some analysts seeing borrowing costs rising above pre-pandemic levels.

Governor Das’s reluctance in a recent interview to commit to the pre-pandemic rate of 5.15% may be an indication of the MPC’s resolve to raise the main repurchase rate beyond that over the next few meetings, said Ananth Narayan, senior India analyst at Observatory Group. 

Market View
 

Bond traders will look for clarity from Das on specific steps the central bank plans to undertake to keep the government’s borrowing costs down. The 10-year bond yields touched 7.5% on Monday, for the first time since 2019, as the MPC started its three-day meet. 

The market is also worried about extra borrowing after the government’s fiscal package, but the current inflationary and liquidity backdrop may not allow the RBI to conduct any immediate secondary market bond purchases, said Citibank’s analysts including Samiran Chakraborty, who said the 10-year bond yields may approach 8%.

“The bond market is already positioned for front-loaded rate hikes,” said Pankaj Pathak, fixed-income fund manager at Quantum Asset Management Co. Any smaller rate hike than the expected 40-50 basis points will be a “positive surprise,” leading to marginal softening of short-term bond yields.