“The RBI is likely to take rates above a level deemed “neutral” (which we think is closer to 5.25%) before slowing down or looking at becoming more data dependent in this rate hike cycle,”
Chief Economist Abheek Barua said in a research note.
Tanvee Jain-Gupta, the chief India economist at the Swiss brokerage UBS Securities, had said that they expect the central bank to hike the policy repo rate by 25-30 bps in the August policy review and another one in October, but the quantum of that increase will depend on the dataprints on the domestic inflation and the shape of the US economy.
On that note, let’s take a look at the movement of key economic indicators since the last policy meeting in June, when the Reserve Bank of India-led rate setting panel had hiked benchmark rate by half a percentage point to rein in inflation that was forecast to remain above the legally sanctioned tolerance ceiling for this fiscal year.
The key driver for the policy decision will be the inflation readings and its trajectory.
Retail inflation in India had eased to 7.01% in June, but the print stayed above the RBI’s tolerance ceiling of 6% for the sixth consecutive month. Consumer prices in India had surged to an eight-year high of 7.80% in April. The overall food inflation came in at 7.75% in June as compared to 7.97% preceding month, while fuel and light inflation climbed up to 10.39% in the month of June in contrast to 9.54% in May.
Core inflation has stayed above 6%.
Last month, RBI Governor Shaktikanta Das said “inflation appears to have peaked,” although he simultaneously underscored the risk of high volatility. Meanwhile, Finance Minister Nirmala Sitharaman had categorically refused to associate terms such as stagflation and recession with the current state of the Indian economy.
The local currency had dropped to a nadir in July, crossing the 80-per dollar mark on July 19. Today, the Indian rupee again inched towards the all-time low against the dollar as the country’s record trade deficit remained a cause for concern. The rupee had dropped up to 79.54 during the session, after closing at 79.16 on Wednesday. The local unit has dropped over 6.5% against the greenback so far in 2022.
According to preliminary government data, India’s trade deficit in July widened to $31.02 billion from $10.63 billion a year earlier, as it spent more on crude oil and coal imports.
Analysts have said the possibility of a 50-basis-point hike by the country’s central bank looks very likely amid the widening trade gap, which is in turn a worry for the rupee as the need for dollar funding surges.
The MPC has increased the short-term borrowing rate twice so far this fiscal – by 40 basis points in May and 50 bps in June to tame retail inflation. The current policy rate of 4.9% is still below the pre-Covid level of 5.15%, which was slashed to record low of 4% in 2020 to tide over the coronavirus induced crisis.
India’s foreign exchange reserves got depleted by another $1.152 billion in the week to July 22, reflecting the unabated fall in reserves albeit at a lesser pace.
The reserves stood at $571.560 billion as against the all-time high of $642.453 billion seen on September 3 last year, Reserve Bank of India data showed.
Reserves had fallen over $15 billion over the two preceding weeks.
While dollar outflows are the major reason behind this depletion, the change in valuation of reserves held in global currencies other than the US dollar is also partly behind this trend.
Out of the current reserves, foreign currency assets stood at $510.136 billion while reserves held in gold were valued at $38.502 billion.
The MPC’s 50-basis point rate increase in June was soon followed by the US Federal Reserve‘s 75-basis point hike, which was the biggest one-time increase in nearly three decades. While in June the Fed had taken the rate to between 1.5% and 1.75%, more hikes now lifted it to a range of 2.25%-2.5%, after starting the year with near zero rate.
St. Louis Federal Reserve President James Bullard recently said he expects another 1.5% rate increase as the US central bank gets agressive to tame inflation.
The rate differential between India and other nations is a key driver for foreign fund inflows and Fed’s rate increases make the Indian market less attractive.
India has already seen $28.69 billion of foreign fund outflows from the financial markets year to date.
Global Crude Prices:
The Indian basket of crude oil had hit a decadal high of $121.28 per barrel on June 10, soon after the MPC’s decision to revise up inflation forecast for this fiscal year to 6.7% on the assumption of a normal monsoon in 2022 and average crude oil price (Indian basket) of $105 per barrel.
The price of India’s crude oil basket has dropped since June and the average for July was $105 per barrel.
Brent crude futures were at $97.31 a barrel, while West Texas Intermediate (WTI) crude futures stood at $91.21. Both the benchmarks had recently dropped to their weakest levels since February.
Banks’ Credit Disbursals:
While the RBI has looked to check a run-away inflation, it will also look to keep the economy humming. While India’s GDP data for the fiscal first quarter is due later this month, demand for loans will be a key parameter to gauge economic activities.
According to RBI data, bank credit rose by 12.89% to Rs 122.81 lakh crore and deposits by 8.35% to Rs 168.09 lakh crore in the fortnight ended July 15.