Mumbai – The Reserve Bank of India (RBI) is likely to implement two repo rate hikes totaling 50 basis points (bps) by December, according to a recent forecast from SBI Research. The first 25-bps increase is anticipated in October, with another following in December. This shift marks a significant change from earlier expectations of a prolonged pause in rate adjustments.
Rising Crude Oil and Inflationary Pressures
The primary drivers behind this projected monetary tightening are surging crude oil prices, which have climbed above $100 a barrel, exacerbated by geopolitical tensions in key shipping routes. SBI Research’s models suggest crude could reach as high as $123 a barrel in the near future. Elevated oil prices pose a substantial risk, potentially pushing India's inflation readings for October and November towards 6.5% or even higher.
Beyond crude, inflation is showing signs of becoming more broad-based. The number of commodities contributing significantly to the Consumer Price Index (CPI) has increased from 22 in January to 53 in July, indicating wider cost pressures across the economy. While headline CPI inflation rose from 2.73% in January to 4.45% in July, core inflation has remained relatively subdued, increasing only marginally to 3.87% over the same period.
The report also highlights an incomplete pass-through of higher input costs to final prices in sectors like crude petroleum, natural gas, beverages, pharmaceuticals, and electronics. Waiting for these costs to fully reflect in CPI could mean a delayed response to entrenched inflation, according to SBI Research.
Bond Market Implications and Global Factors
The prospect of an RBI repo rate hike comes as India's benchmark 10-year government bond yield has already surpassed 7%. SBI Research expects these yields to climb further, potentially towards 7.15% or higher, as oil prices contribute to imported inflation and exchange-rate pressure, creating uncertainty around the central bank's policy actions.
Globally, bond markets are also under strain, with the US 10-year yield approaching 5%. The probability of a September rate hike by the US Federal Reserve has reportedly increased to 71% from 61%, adding to the complex global economic backdrop.
RBI's Liquidity Management Dilemma
The RBI faces a challenging liquidity management situation, partly due to a significant surplus generated by FCNR(B) deposit mobilization, which reached $127.22 billion by August 31. While this liquidity is expected to be temporary, absorbed by strengthening credit demand, aggressive withdrawal measures could create a deficit during peak credit demand quarters.
SBI Research stressed that clear, credible, and consistent RBI communication will be essential to anchor inflation expectations and preserve policy credibility.
Given that FCNR(B) deposits are exempt from CRR, a CRR increase is not deemed advisable at this juncture. Instead, options like Variable Rate Reverse Repo (VRRR) auctions, Market Stabilization Scheme (MSS), and selective retirement of RBI’s short-dollar positions are potential tools for liquidity absorption. A measured, shallow rate hike could also demonstrate the central bank's agility in responding to evolving external shocks.