Will the RBI hike rates to stem the fall in the rupee

Ahead of the RBI Monetary Policy Committee (MPC) policy announcement on Friday, the big question is not of whether but how much the RBI will hike rates. The RBI made an unscheduled rate hike of 40 bps in May along with a 50 bps hike in CRR. This was followed up by two 50 bps rate hikes in the June policy and the August policy. In all, between May and August, the RBI has hiked repo rates by 140 basis points from 4.00% to 5.40%. The repo rates are already above the pre-COVID rates of 5.15% and the RBI may not be done yet. The October policy assumes significance for its guidance, which his expected to be hawkish.

What is expected in the October monetary policy?

The RBI policy coms after the US Fed has raised rates by 75 bps each in the last 3 Fed meets, even as consumer inflation continues to be sticky. Here is what to expect from the October monetary policy announcement on 30th September.

    a) The virtual consensus is that the RBI would hike the repo rates by another 50 bps to take it to the 5.90% levels. However, some optimists do believe that the RBI may settle for a 40 bps hike instead of a 50 bps hike. Some also expect that it may decide to spread the hike between the repo rate and the CRR, which does look unlikely. 

    b) The RBI language will be critical. In the last few policies, the RBI has maintained the tone that it was committed to exit the quantitative easing. However, the RBI has avoided sounding too hawkish. This policy, the RBI may actually send hawkish signals.

    c) GDP growth remains a major moot point. The RBI has held on to its GDP growth estimates of 7.2%, but with the global recession looking likely and the trade getting negatively impacted, the RBI may lower the growth forecast for FY23 to below 7%.

    d) On fear is that the terminal rate may now get shifted up from 6% to 6.5% and the RBI may also choose to front load most of the rate hikes. For instance, the RBI may choose to hike rates by 50 bps in the October policy and another 50 bps in the December policy so that the 6.5% termina target for repos is front-loaded in 2022 itself; like the US.

    e) While the fuel inflation is tapering, India is feeling the pressure of rising food inflation and also core inflation (non-food and non-oil). The RBI is likely to stay hawkish so as to quickly rein in inflation and speed is the key here.

    f) One can expect policy measures in this policy from the RBI as a pre-emptive measure due to the current account deficit likely to burgeon to 5% of GDP for FY23. The government would also be worried that FPI flows have been consistently negative putting more pressure on the rupee.

But, actually RBI may stay hawkish to defend the rupee

One very important reason the RBI may remain hawkish in the Friday MPC meet is the consistently weakening Indian rupee. Over the last few months, the RBI has been using its reserves to defend the rupee. In the process, the RBI reserves have fallen from $642 billion to $545 billion. However, during this same period, the rupee has fallen from 76/$ to nearly 82/$. Thus the RBI may be looking at policy measures beyond spot dollar sales to defend the rupee. The easiest method would be to aggressively hike the repo rates. Here is why.

Globally, the currencies have strengthened when rates are hiked. Since the US Fed embarked on a patently hawkish policy stance, the dollar index (DXY) has consistently strengthened and as of date, the dollar index is already at a 21-year high. The strength of the dollar is already visible against most of the currencies including the Euro, Yen, Yuan, Pound and even the rupee. The best the RBI can do is to maintain the monetary policy hawkish so that higher rates promise persistent capital flows into India and arrest the fall in the rupee. At least, that is what will be the endeavour of the RBI in this policy.