India: rates paused, peak likely reached

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India’s central bank paused on its monetary tightening policy that had seen 13 interest rate hikes since March 2010 in order to fight persistently high inflation, in a widely expected move.

The decision comes at a time when Asia’s third-largest economy is faltering, with a weak currency, widening trade, fiscal and current account deficits, foreign outflows and lowered GDP growth expectations.

The Reserve Bank of India (RBI) was trying to balance these economic woes with the inflation concerns that have occupied it for nearly two years, economists told beyondbrics.

“They have very much [kept] inflation on the radar, but quite clearly growth has increasingly come under policy focus, which indicates that the next action would be a rate cut sometime by March if we read the assessment correctly,” said Shubhada Rao, chief economist at Yes Bank.

In general, the RBI kept to its cautious approach, leaving the repo rate, the rate at which the central bank lends to commercial banks, at 8.50 per cent after its quarterly policy review meeting.

But the language of its guidance, which is keenly watched by economists and the markets, indicated that interest rates might be at their peak, if inflation, which is still at above 9 per cent, continues its downward trajectory.

“From this point on monetary policy actions are likely to reverse the cycle, responding to the risks to growth,” the RBI said in a statement.

Still, the central bank’s loosening strategy runs the risk of being derailed by a looming domestic currency crisis. The rupee, which has fallen over 18 per cent since the beginning of this year, touched a new record low on Thursday as it crossed 54 against the US dollar.

“Despite the slowdown in growth, excess demand is keeping underlying inflation pressures in place,” said Leif Eskesen, HSBC’s chief economist for India. Moreover, delayed pressure on prices and the weakening of the currency are adding to inflation, he added.

The RBI seemed conscious of that on Thursday night, when it intervened to hold off the steep drop of the rupee, as it reached a new record low each day this week. It reduced trading limits for banks in the forex market in order to quash on speculation that has been seen as accelerating the rupee’s downward trajectory.

“I think quite clearly they want to probably crunch any speculated positions … the underlying intention of yesterday’s news on introducing stringent measures on forward markets was to quash the speculation that has been fuelled the last few weeks,” Rao told beyondbrics.

Still, Rao said that the RBI’s move was unlikely to reverse the rupee’s fall significantly. The rupee will probably decline as India’s trade and current account deficits widen and eurozone worries prompt foreign institutional investors to continue to pull out of emerging markets and to seek safe haven in the US dollar.

Related reading:
India leaves rates unchanged, FT
India eyes drastic measure as economy lists, FT
India: Delhicately poised, Lex
Rupee: how low can you go? beyondbrics

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