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With the Reserve Bank of India (RBI) expected to continue its battle against inflation, the festive season is unlikely to deter it from increasing the repo rate at the end of this month. However, the central bank may introduce more measures to reverse the tight liquidity conditions to ensure credit flows are not unduly constrained during this period.
“RBI will also have to demonstrate that it is serious about anchoring inflation expectations, which means it will have to further hike the repo rate and continue to communicate a hawkish stance,” said Leif Lybecker Eskesen, chief economist of HSBC for India and Asean region.
Eskesen expects RBI to increase the repo rate by at least 25 basis points this year while continuing with liquidity enhancing measures, including further reduction in the marginal standing facility (MSF) rate, at which banks borrow funds overnight from RBI against approved government securities.
“These steps may well come as soon as the October monetary policy meeting, although data flows and external developments would be important determinants of the timing and magnitude of future steps,” Eskesen added.
On September 20, in the mid-quarter review of monetary policy, RBI had increased the repo rate, at which it lends money to banks, by 25 basis points to 7.5 per cent as inflation expectations continued to remain at elevated levels.
It also reduced the MSF rate by 75 basis points to reverse the tight liquidity situation. On Monday, the central bank announced a further reduction of 50 basis points in the MSF rate to nine per cent and announced more steps to ease the cash squeeze.
“Though Monday’s MSF rate cut loosens monetary policy, RBI under new Governor Raghuram Rajan appears to be taking a more hawkish stance with regard to inflation. At its next scheduled policy meeting on October 29, we expect RBI to raise the reverse repo and policy repo rates by 25 basis points; and then a further 25 basis points hike in these rates, to end the year at seven per cent and eight per cent, respectively,” said Roland Randall, senior economist of ANZ for the Asia-Pacific region.
While a lower MSF rate is likely to bring down short-term rates, industry analysts are still doubtful if banks will be willing to cut their lending rates. Bank of America Merrill Lynch (BoFA-ML) estimates credit growth to decelerate to 11 per cent as borrowing costs are expected to remain high.
“We expect total credit growth to fall to 11 per cent, as banks are unlikely to cut lending rates. Also, capex and infra-loan growth may be five per cent, owing to a slowing new pipeline,” Rajeev Varma and Veekesh Gandhi, research analysts with BoFA-ML, wrote in a note to clients after RBI cut the MSF rate on Monday.
