It appears certain that the RBI will do what it hasn’t done in four years—raise rates. The question is no longer if, but when. Wednesday’s outcome could be a repeat of the April policy—where the RBI sounded hawkish, but acted dovish—but that will end up as all gong and no dinner. Hardening crude prices, sticky inflation, weakening rupee, etc., are enough reasons to take the foot off the monetary policy pedal. But it’s equally possible to wait for further data, to separate signal from noise. So the 25 bps hike, of the 50 bps markets priced in, may well come Wednesday or in August.
The spread between 10-year bond yields and repo rate is already wide at 195 bps —the highest since March 2009. Typically, volatility in long-term yields results in financial instability, but FPIs exposure to government bonds is less than five per cent. The RBI may thus have to worry less about capital flight. But underlying price pressures warrant a rate hike.
Soaring oil prices dragged rupee from being the best performing Asian currency last year to one of the worst in 2018; the rupee may weaken further unless it’s tossed some raw meat. Although the monsoon could be normal, higher minimum support price could push inflation. As it is, India is the only region within APAC where core inflation is higher than the inflation target, which is enough ammunition to hike rates.
That’s a luxury, critics say, the RBI doesn’t have, as rate hikes wreck the economy without a shot being fired. The GDP may have grown at 7.7 per cent in Q4 of FY18, but in reality, private consumption is weak and higher rates will strain consumption and demand. But the presumption of rate hikes choking economic and credit growth is alarming when economic and monetary instruments are managed by interest rates alone, which fortunately isn’t the case for us. Amid conflicting signals, the RBI should know how to thread the needle and when to lurch between hike and halt.