By Jaspreet Kalra
MUMBAI, June 2 (Reuters) – India’s central bank faces one of the toughest interest rate decisions in recent memory this week, as the Middle East energy shock, a free-falling currency and a weak monsoon risk slowing growth and stoking inflation.
The rupee has fallen to record lows since war with Iran broke out in late February, as the resulting rise in crude prices dealt a blow to Asia’s third-largest economy, which imports almost 90% of its oil needs.
An increase in the Reserve Bank of India’s official repo rate from the current 5.25% on Friday could comfort the currency, but could also irritate the rates market, which sees room for the central bank to stay put while inflation remains below target.
The RBI is approaching the June meeting with the “dilemma of whether to respond to market pressures or incoming data,” Rahul Bajoria, chief India economist at BofA Global Research, said in a note.
“An aggressively oriented hold would probably be the most elegant compromise, where the RBI does not signal any panic about exchange rate stability, but conveys a willingness to remain vigilant,” Bajoria said.
Nearly 80% of 56 economists surveyed by Reuters expect the central bank to keep the repo rate unchanged at 5.25% as it concludes its three-day meeting.
Of the remaining respondents, 11 predicted an increase of 25 basis points, while one expected a larger increase of 50 basis points. The central bank’s official interest rate has remained unchanged since December, following 125 basis points of rate cuts last year.
Interest rate swaps are discounting nearly 100 basis points of adjustment over the next 12 months, with the one-year OIS rate rising 65 basis points since March. This is a much more aggressive rerating than in the bond market, where benchmark 10-year yields have risen 37 basis points over the same period.
RUPEE RATES
While still-benign inflation may offer room for maneuver to the central bank at the moment, some analysts argue that monetary policy must come to the rupee’s defense sooner rather than later.
Rate hikes by oil-importing peers such as Indonesia, the Philippines and Sri Lanka have reinforced bets that the RBI could eventually be forced to follow a similar path. But India’s central bank is not in favor of monetary policy action to defend the rupee, Reuters previously reported.
A preemptive rate hike would probably be “the positive offset for the moment,” said Carl Vermassen, portfolio manager in the emerging markets fixed income team at Zurich-based Vontobel Asset Management.