MUMBAI: A rate hike by the Reserve Bank of India (RBI) next week is assured with the US Federal Reserve increasing interest rates by 75 basis points (100bps = 1 percentage point). With the rate hike already priced in, bond, currency and equity markets will likely heave a sigh of relief. However, the Fed has left the market guessing about future moves.
The Fed Open Markets Committee raised its benchmark overnight interest rate unanimously by 75bps for the second time in two months. However, the policy statement did not give any explicit guidance on what steps it will take next, stating that it will remain “highly attentive” to inflation risks.
It is widely expected that the RBI would hike rates by 35-50bps despite believing that inflation has peaked in India. This is because the central bank will need to ensure that there is an interest rate differential between India and the US to attract dollars at a time when the country is expected to witness a record current account deficit and may have to dip into reserves to maintain the balance of trade.
State Bank of India Group chief economist Soumya Kanti Ghosh expects the RBI to hike interest rates by 35bps, bringing interest rates to where they were before March 27, 2020. That’s when the central bank began its rate-cutting cycle to alleviate the damage caused by the pandemic.
According to Ghosh, the US Fed is hiking rates now as it could not anticipate the rampaging inflation threat. He adds that for the labour markets to come to their balanced 2019 state, unemployment rate would have to rise from 3.6% today to more than 6%. The strong labour market in the US portends a very peculiar situation of slow growth and high inflation, and a possible recession with high employment, said Ghosh in a report released before the Fed rate hike.
According to Dun & Bradstreet’s global chief economist Arun Singh, the RBI will be under pressure to further raise interest rates. This would be due to depreciation pressures on rupee and the elevated inflation. FII outflows, along with the intervention by the RBI, is causing depletion of forex reserves, adding pressure on the rupee, he said in a report released on Wednesday ahead of the Fed rate action.
“Forex reserves fell to a 15-month low in June 2022. In addition, a widening of the trade deficit to all-time high coupled with downside risks to growth will continue to exert downward pressures on rupee,” said Singh.