Edelweiss,: RBI Policy Preview - RBI likely to maintain status quo on policy rates

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In the forthcoming quarterly review of monetary and credit policy on November 02, 2010, the RBI is likely to maintain status quo on the policy rates, leaving repo rate, reverse repo rates and CRR unchanged at 6%, 5% and 6%, respectively. This expectation is based on our assessment of the evolving domestic and global macroeconomic scenario and RBI’s last meeting’s policy stance. Domestically, while the economic momentum remains healthy, some softness is observed in industrial production, PMI indices and exports growth. Growth in money supply has been quite soft, credit growth is yet to pick up strongly, and inflation momentum is slowing. These trends confirm our stated belief that there is no demand overheating in the Indian economy. Hiking interest rates against such a macroeconomic scenario could hurt business sentiments and, hence investments, especially when monetary stance has already reached close to normal.   

Internationally, expectations around another round of quantitative easing (QE) measures by the Fed and associated surge in capital inflows to emerging markets (EM) are presenting fresh challenges to EM central banks, including RBI. First, the sudden surge in capital inflows to India raises concerns of financial stability. On one hand, these flows are quickly reversible and, on the other hand, they chase asset prices higher in a short span. Second, capital inflows are putting upward pressure on INR, thereby hurting the export sector. Third, expectations of Fed’s QE are driving the global commodity/energy prices higher, which, in turn, influence the domestic inflation trends. Here also, raising interest rates could prove counter-productive as it will attract even more foreign capital into the country. Against this, we expect RBI to pause in the forthcoming policy meeting. However, it is quite likely that if capital inflows continue to remain very strong, RBI will intervene in the forex market to check INR appreciation. Further, the forex intervention could be unsterilised as domestic liquidity conditions remain tight and money supply growth is running below target.