We have argued “Hike the interest rate now“, 1st June, 2018) that the current macroeconomic situation warrants a policy rate hike. Rising and more dispersed core inflation, the immediate and possible second-round effects of the fuel price increases and the pressure on the rupee; all call for a 25 basis point hike in the repo rate in the June 6th policy. There are looming risks like a significant hike in the procurement prices of major food grains and more aggressive procurement. The first risk would add 25-30 bps in our estimates to CPI inflation while the second would augment rural demand and pressure up the prices of a wide range of consumer items. In a pre-general-election year, with key farming states going to the polls and a slew of farmer agitation demanding better realizations on their crops, a tangible hike in the government’s procurement prices should be a given. The 7.7 per cent GDP print for Q4 FY18 that came in higher than expected seems to suggest that there is evidence of demand-pull factors at play and going by basic economic theory is pulling core inflation up.
That said opinions are different from forecasts. There appears to be considerable divergence within the Monetary Policy Committee (MPC) on the assessment of inflation and the appropriate policy response. It has also appeared to us , at least, that the governor would delay a hike unless it becomes imperative. The dominant bias of the central back is not to enthusiastically proactive but ‘wait and watch’ for more clarity on key developments (that alas, in our opinion will remain elusive). Thus with the key risk of depreciation pressure on the rupee dissipating and oil prices stabilizing we expect a hold in the June policy.
To be fair to the RBI, it has not been entirely reticent in its response to the oil price increase and rupee fall. Liquidity has been tight and there have episodes of aggressive intervention in the currency market. That might ease a tad were the reversal in the trajectory of the prices of oil and the rupee. Let’s wait and watch.
*Mr. Abheek Barua, Chief Economist, HDFC Bank. Mr. Barua tweets at @AbheekHDFCBank.