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Why RBI is likely to hike rates by 25 bps in October policy
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$200 billion
US President Donald Trump announced an additional 10% duties on Chinese imports worth around $200 billion on 17 September 2018. This has ushered the trade war into a new phase. Experts suggest that the impact of the new tariffs on China will be visible in emerging markets like India sooner or later.
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Publish date: 21st September, 2018
There has been a lot of drama going on in the financial markets in the recent past. The rupee has just recovered from its all time low against the dollar, crude oil prices are rising and there seems to be no end to the global trade war. Amidst all these developments, there has been a constant pressure on the Reserve Bank of India to control the rise in inflation and the depreciation of the rupee. Here are the reasons why the RBI might hike interest rates by 25 basis points during its monetary policy meeting in October.
1) Inflation concerns
The RBI’s Monetary Policy Committee (MPC) does not target the exchange rate during its bi-monthly meetings. Instead, the biggest goal is to contain rising prices in the country. The central bank hiked interest rates to 6.25% for the first time in four years in June 2018. This was followed by another hike by 25 basis points in August. Following these measures, there has been a softening of domestic inflation from 4.84% in June to 3.69% in August according to a report by the Hindu Business Line. However, a spillover of the rising crude oil prices and a weak rupee indicate that the RBI may take active steps to curb inflation.
6 effects of rising crude oil prices on the Indian economy
2) Rupee woes
The Indian rupee has been under tremendous pressure lately. Recently, it touched a historic low of 72.99 against the US dollar. This was a result of an escalating trade war problem and rising crude oil prices. The rupee has fallen by more than 13% since the beginning of the year.
While the RBI’s mandate is to control inflation, experts believe that a further 10% depreciation in the rupee could add another 50 basis points (bps) to inflation. As a result, there has been a growing demand for the Reserve Bank of India (RBI) to step in and arrest the rupee’s decline during the Monetary Policy meeting in October.
Rupee falling? No need to hit the panic button… yet
3) Rate hike imminent
If the rupee depreciation continues at this rate, a rate hike would be the best option according to Soumyakanti Ghosh, the chief economist of SBI group. Most experts believe that a 25 bps hike is imminent while a few others say that even a 50 bps hike wouldn’t be a big surprise. The recent rupee depreciation and the threat of rise in oil prices could have a big impact on inflation. In addition to this, the US Federal reserve may hike interest rates in the coming week. Analysts believe that the MPC would have to follow suit and hike rates in order to maintain the interest rate differential.
4) Current Account Deficit
India’s Current Account Deficit (CAD) for the April-June quarter has increased to $15.8 billion from $15 billion during the same period last year. This is equal to 2.4% of the entire Gross Domestic Product (GDP) of the country. And with the US President Donald Trump slapping tariffs and announcing trade wars, there is little hope of a reduction in the trade deficit any time soon.
