BY MANISH WADHAWANIn their unwavering pursuit of containing inflation at 4% in the medium term, RBI hiked the repo rate by 25 bps.
The decision comes in the backdrop of existing uncertainties, both global and domestic, the risks being the outcome on inflation, taking into account MSPs increase in the coming months, volatile crude oil prices, and strong economic recovery across various sectors stoking demand push inflation.Internationally, the currency market volatility and the unwinding of stimulus by various central banks have added to the risks.I think RBI could have stayed put and waited and watched.
But, prudence prevailed and hence we saw them hiking the repo rate.
The other key point to note is maintaining the stance at neutral.
As the economic environment remains challenging, the decision is most apt as it gives enough leeway to the central bank to react either way depending on data.
With this hike, RBI has bought some time before it acts again.
We expect RBI to be on a long pause till Q1 2019.The financial conditions are expected to tighten in the second half of the year aiding the central banks stance.
In fact, RBI might have to step up the open market operations to sustain liquidity in the system.
The external sector will be challenging as trade deficit soars, and FPIs uncertainty on EM and a tightening policy stance from central banks across the globe pose serious challenges to capital flows.
The domestic economy seems to have overcome the effects of demonetisation and is showing signs of strength across sectors.
Revenue collections seem to be on track till June and the final picture on the fiscal front will be evident only by the year-end.
Unless we get a shock from the international markets, we may see calm for a few months.The medium term impact of the two rate hikes will be felt in the financial markets in the next few months, in the form of higher deposit and lending rates.
This should help manage the demand pull impact on inflation.Overall, its going to be a tough environment for the financial markets as the tightening takes hold and financial intermediaries re- price the cost of credit and liquidity.
It shall also help the exchange rate stabilise, which off late has been quite volatile.
Overall, I would say it was a prudent call by the RBI, considering the tough task of balancing the risks and continuing to support growth.(Author is head of fixed income, global markets at HSBC India)