Why inflation and a falling rupee may push RBI to hike rates in June

With continuing pressure on the rupee and expectations that it could breach the 100-mark against the US dollar in coming weeks, there could be a rate hike when the monetary policy committee of the Reserve Bank of India meets for its next review in June.

The fall in the rupee and exit of foreign investors is fast becoming a concern for policymakers in New Delhi and the RBI as the conflict in West Asia continues and oil prices remain high at over $100 per barrel. According to sources, the finance ministry, which has been constantly monitoring the situation, is also looking at possible measures to improve sentiments around the domestic economy and encourage foreign investments.

On Thursday, Standard Chartered said it expects 50 basis points of rate hikes to 5.75% in FY27, beginning in June due to higher retail inflation. “This reflects an upward revision to our FY27 CPI forecast to 4.9% from 4.7% and increased depreciation pressure on the Indian rupee (INR),” it said in a note.

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While the MPC has reiterated that its repo rate decisions are driven more by domestic growth and inflation dynamics than by the need to defend the currency, the sharper-than-expected pace of INR depreciation (INR is trading at 96.80 versus our June-end forecast of 93) raises the risk of second-order effects on CPI and, in our view, strengthens the case for a hike, it further said.

The six-member MPC, chaired by Reserve Bank of India Governor Sanjay Malhotra, is set to meet from June 3-5.

CPI inflation rose to 3.48% in April, which was softer than anticipated but with the Rs 3.9 per litre hike in petrol and diesel prices, it is seen to rise in May and June. Wholesale inflation, which rose to a 42-month high of 8.3% in April, is seen to reflect the rise in prices although the RBI does not track it for rate setting purposes.

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The RBI on Wednesday announced a $5 billion dollar swap and market participants expect more measures and is seen to have also intervened in the market to keep the rupee from breaching the 97-mark on Thursday. On Thursday, the rupee gained 49 paise and closed at 96.37 against the US dollar.

Jateen Trivedi, VP Research Analyst - Commodity and Currency, LKP Securities said that market participants also sensed possible intervention support, which helped improve sentiment in the forex market.

“A pullback in crude oil prices further supported the rupee, with WTI crude slipping below the $101 mark, easing immediate concerns around India’s import bill and inflation pressure.

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The recovery in rupee is currently being driven more by profit booking and softer crude prices rather than any major structural reversal, though lower oil prices can continue to provide temporary relief to the currency,” he said.

The fall in the rupee not only reflects weakened investor sentiment but also causes challenges on the balance of payments, making imports more expensive, especially at a time when crude oil and fertiliser prices have already become a pressure point for the Exchequer.

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