Saturday, May 19, 2018

Two rate hikes coming; first one maybe in August

Certainly. This is a difficult situation that we find ourselves in and it is going to be a wait-and-watch. We need to see for how long crude prices sustain at these levels internationally and obviously that will have some effect either on inflation or on fiscal deficit, depending on whether there is a full pass through to domestic consumers or if a buffer comes in via lower excise duty or VAT charged by state governments. 

In terms of the impact on fiscal deficit, the government would possibly prefer to wait till they get at least another month of the GST numbers to be able to see whether that spike that we got in April is sustained going into the new fiscal year as well. 

If that is the case, then perhaps we could expect to see a modest excise duty cut. Excise duty is not something that could be cut and then raised again very soon in case crude oil prices fall. Whatever decision is taken, it would be very well thought out and possibly instead of a big ticket cut, we would see modest cuts especially if crude oil prices sustain at higher levels or go up further 

I do not think those decisions should be expected until at least we have some clarity on where the GST numbers are going to settle. 

In June, the Fed meet is almost certain to see the US Fed hike interest rates. Given that we are seeing rupee depreciation and we are seeing bond yields move up very sharply, almost close to 8%, one could argue that the RBI is much behind the market. Does RBI need to hike rates in June itself or does it have the luxury of waiting? 

I agree partly with Dr Goyal. My personal view is that the way we saw average inflation coming off in FY18 and the fact that we had only one rate cut of 25 bps, to have some synchronicity and with average inflation likely to go up by 100 bps to a minimum baseline of 4.6% on average in FY19, one rate hike at some point is priced in. 

If crude oil prices sustain at $80 and beyond and there is a full pass through in the domestic prices, then the second-round impact happens. After that, the worst-case scenario that we are looking at is that the average CPI inflation could go up to somewhere around 4.9% or so from a baseline of 4.6%. 

Therefore, instead of the one rate hike that I was talking about earlier, there could be two rate hikes in FY19. We do not think the first one will come as early as June because there are a lot of other moving parts in the inflation trajectory. But there will be greater clarity by July or August. As of now, we are expecting the first rate hike to come in August or after that, depending on how all of the moving parts settle down. 

In terms of whether RBI is behind the curve or not, bond yields anyway have gone up so much and in terms of the banking sector also, the ability of all banks to support credit growth right now is really not there. 

I am not sure if the RBI will hike the repo rate in June versus August because that is going to have a big upward impact on bond yields. The tone of the policy document and the minutes are going to be very important from the June policy but it is going to be more the outlook for crude oil prices as well as the number of rate hikes from the US Fed, that possibly would be much bigger factors driving up the Indian bond yields. The market is already pricing in some amount of rate hike by the MPC. 


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