Reserve Bank of India (RBI) monetary policy outlook
The RBI will release its Fourth Bi-Monthly Monetary Policy Statement for the year 2018-19 on October 5th. It is being widely expected that the RBI will increase the repo rate by 25 basis points given the falling rupee and the rising price of oil. The mandate of the RBI is inflation stabilization – as measured by the consumer price index – at its medium-term target of 4%. Annual inflation in August 2018 was 3.69%, below RBI’s target. The balance between on the one hand the continued strength of the Indian economy and on the other macro and banking and financial services sector concerns will determine the interest rate outlook. The looming US sanctions on Iran in November and the reluctance of Russia and the Organization of the Petroleum Exporting Countries (OPEC) to raise output could tighten global oil supplies putting further upward pressure on the oil price which is expected to be around USD 90/barrel. This has the potential to put brakes on India’s gross domestic product (GDP) growth rate due to higher energy costs, raise inflation if higher energy costs persist, and raise the current account deficit (CAD) because of at least status quo imports assuming, despite the cheaper rupee, exports will be unable to offset the higher cost of imports. Higher import prices will also pass through into inflation. Slower growth could reduce tax revenues thereby raising the budget deficit. Further, on the budget deficit front, budget numbers for 2018-19 were calculated on the basis of oil at USD 65/barrel and rupee at around 66 to the dollar. Those calculations no longer hold. Oil subsidies, budgeted at just under INR 25,000 crore for 2018-19, may end up 40% higher or more in actual expenditure. The rising dollar because of strong US economic growth is depreciating the rupee which is compounded by selling rupee to buy dollars to pay for imports. These factors and rising US interest rates are driving away foreign institutional investors (FIIs) who are, on net, taking dollars out of India, putting pressure on India’s foreign exchange reserves. At the present time, however, India’s macro situation, though experiencing negative pressures, continues to be stable. Higher interest rates in India is one way to attract FIIs but RBI may not be inclined to sap liquidity from the market by raising the repo rate amid talk already about lowering the reserve requirement and RBI bond purchases from banks to ensure that the markets are sufficiently liquid to prevent panic selling. As the non-banking financial companies’ (NBFC) regulator it will also need to address what steps it may take, if any, about possible defaults by companies in that space. A contagion involving NBFCs could drag the equity markets and the economy down with it. The RBI, while intervening in the foreign exchage market as necessary by selling dollars and buying the rupee could, however, hold off on raising interest rates for this meeting but with an eye on the affect of oil price and the macro situation on inflation outlook for future meetings rather than using higher interest rates to put a floor under the falling rupee.