RBI Monetary Policy Preview: Local Inflation Woes To Outweigh Global Financial Concerns

India's Monetary Policy Committee is likely to hike the key lending rate at its first meeting in the new fiscal as fresh concerns around domestic inflation are likely to outweigh weak global conditions and recent events in the banking system.

A Bloomberg poll of 15 economists shows a median forecast possibility of a 25-basis-point hike in the Reserve Bank of India's repo rate to 6.75%. The policy repo rate is currently at 6.50%.

"We expect another rate hike at next week’s MPC meeting as inflation remains outside of the central bank’s tolerance band," said Rahul Bajoria, chief economist at Barclays, in a note. The rate-hiking cycle itself is likely coming to an end as inflation rolls over, global monetary pressures reduce, and the external deficit shrinks, he said.

However, Soumya Kanti Ghosh, group chief economic advisor at the State Bank of India, expects MPC to maintain the status quo. Considering the repo rate is already around 25 basis points higher than the optimal requirement based on CPI, core CPI, and the U.S. federal funds rate, a 6.5% repo rate could be considered the terminal rate, he said.

India's consumer price index-based inflation stood at 6.44% in February in comparison to 6.52% in January, remaining above the central bank's target range for the second straight month. Core inflation, excluding food and fuel, stood at 6.23%, against 6.28% a month ago. 

The average CPI inflation for Q4 FY23 is set to surpass the RBI’s estimate of 5.7% unless we see a significant drop in the March number, according to CareEdge, which forecasts headline retail inflation at 6.2% for the quarter. The spike during the past two months was mainly food-driven, but the stickiness in core inflation above 6% for over a year is worrisome, it said. There are upside risks to food inflation due to unseasonal rains and in the event of El Nino-led disruptions. "At this juncture, it becomes important for the RBI to reinforce its commitment towards taming inflation."

Liquidity in the system has turned deficit with the net liquidity adjustment facility injection at Rs 45,000 crore as of March 22, 2023, compared to a surplus of Rs 6.35 lakh crore at the beginning of the fiscal year, according to SBI Research.

The average core liquidity has dropped to Rs 1.59 lakh crore, which is less than the RBI's non-inflationary amount of 1.5% of NDTL, which is currently Rs 2.86 lakh crore, it said. "By March-end, we expect that the system might be in a liquidity deficit within tolerable limits if there are no liquidity injections or withdrawals," Ghosh said.

The government bond yield curve is expected to steepen as the supply of long-tenured bonds increases, according to Madhavi Arora, the lead economist at Emkay Global Financial Services. This, combined with the possibility that the RBI is approaching the end of the rate hike cycle, favours the shorter end of the G-sec curve over the longer end, she said.

As the rate cycle comes to an end, the RBI's stance on rates and liquidity is likely to drive the 10-year benchmark G-sec yield to trade in the 7.25–7.5% range in the near future, according to Arora. The other push-and-pull factors that will likely keep the 10-year bond yield range-bound with an upward bias include the evolution of demand from insurance and mutual funds amid changes in taxation norms, the consistent global repricing of rates amid still-elevated yet falling inflation, bad monsoons and higher domestic food inflation, and easing global commodities, including Brent crude oil, she said in a March 30 note.

The Indian currency has marginally appreciated by 0.2% since the last monetary policy committee in February, closing at 82.3 against the U.S. dollar on March 29.

The rupee will be trading with an appreciating bias due to March-end flows, said Ritesh Bhansali, vice president at Mecklai Financial Services Pvt., who expects it to trade between 82.10 and 82.40.

"Post April, we expect the RBI to be on pause, with no rate cuts expected before the end of 2023," said Bajoria of Barclays. The RBI will be cautious about reversing its rate hikes, given its earlier hawkish stance, the risks of continued elevated inflation, and the uncertainty surrounding geopolitical events and their impact on international commodity prices. Risks to domestic food inflation from climate-related events like El Niño still persist, he said.