Prioritizing inflation over growth, the Reserve Bank of India (RBI) has effectively raised rates by 130 basis points since April 2022.
In a recent report, brokerage house Bank of America (BofA) Securities said that it sees the RBI hiking the policy repo rate by 35 bps to 5.25 percent, higher than the pre-pandemic level. It has revised up its call from a 25 bps hike earlier. The RBI meet will convene between 3-5 August.
The brokerage also believes that the central bank will change its stance to calibrated tightening from the withdrawal of accommodation but retain its CPI and real GDP growth forecasts. The possibility of an aggressive 50bp and a measured 25bp hike cannot be ruled out either, it said.
Let's understand why BofA increased its rate cut forecast from 25 bps to 35 bps:
Rupee: The brokerage noted that between June 8, 2022, and now, the rupee has depreciated 2.6 percent, alongside other emerging market currencies, adding that the domestic fundamentals with respect to external accounts have turned marginally negative with the persistently high trade deficit and continuous FII equity flows. Accordingly, its forex strategist now sees the rupee at 82/$ by December 2022 and 83/$ by March 2023, which is a new risk.
Inflation: Post the US CPI inflation print, market pricing of an even more aggressive rate hike ahead by the FOMC has risen, said the brokerage. In fact, many central banks (Bank of Canada, ECB) have surpassed market expectations regarding their own rate hikes and some have announced out-of-turn, surprise hikes too and such developments make it relatively convenient for the RBI MPC to undertake another non-standard move, explained BofA.
Monsoon: Lastly, BofA pointed out that while monsoon rains have seen encouraging progress, the same is yet to show in the area sown under Kharif crops, which as of July 22nd is down 31 percent YoY, with area sown under the key rice crop, down 16 percent YoY. This is another evolving risk, as per the brokerage.
"The RBI governor in the June policy was very clear that going forward the RBI will be dynamic and pragmatic. He refrained from giving any forward guidance and remarked that the RBI will not be bound by stereotypes and conventions. A less aggressive, non-standard 35 bps hike by the RBI MPC looks most appropriate in this context," said the brokerage.
With a 35 bps hike, the policy repo rate would go to 5.25 percent, above the pre-pandemic level of 5.15 percent, thus withdrawing from the accommodation, it said. BofA further sees the RBI evaluating the incoming data and resorting to standard, more measured hikes thereafter, taking the policy repo rate to 5.75 percent by March 2023.
However, the BofA also delved into the two other possible scenarios - a 50 bps or a 25 bps rate hike.
If the RBI MPC decides to send a more decisive signal, then it can continue with sharp rate hikes, raising the policy repo rate by 50 bps in August, joining some developed and regional central banks said the brokerage.
"The inflation battle is far from won, though early signs of softening of momentum are visible. However, with CPI inflation set to be still higher than the 6 percent threshold until Q4FY23, it is likely that the RBI MPC continues to frontload rate hikes and compress demand enough, in order to bring inflation down, closer to the 4 percent target. Central banks across the globe are responding to rising inflation in a fairly aggressive manner and RBI MPC joining that bandwagon is quite probable too," BofA said.
After having frontloaded the rate hikes, the brokerage said it could see the RBI MPC turning more calibrated going forward with potentially 2 more hikes of 25 bps each in September and December in this scenario. In this case, the stance could change to tightening and repo could be raised to 5.9 percent by March 2023, it added.
On the other hand, it said that it also cannot completely rule out a 25 bp hike as the MPC could acknowledge that inflation has peaked and cites downside risks to their estimates, resorting to standard, more measured hikes. If the RBI MPC decides to resort to a more measured hike of 25bp, citing downside risks to their CPI inflation forecast of 6.7 percent YoY, then the repo rate could go to 5.65 percent by March 2023, it added. In this case, it sees the stance change to calibrated tightening.
"Since Aug 2019, after having cut repo rate by a non-standard 35bp, RBI resorted to standard moves thereafter and has seldom used 2 non-standard moves in the same cycle. With that backdrop, the RBI MPC could go back to hiking rates by standard 25bp going forward," noted BofA.