The Monitory Policy Committee(MPC) of the RBI is mandated to provide the framework for Monitory Policy implementation. The Governments Monitory policy directive to the RBI is to“Maintain price stability and facilitate economic growth”.

The Repo is a benchmark that Banks use to decide their Credit and Savings interest rates. The Repo Rate is currently at 6%. The next MPC is due in 05June. MPCs decision to hold the rate or change it depends on the following.

Inflation

The increase in petroleum prices globally has impacted the Rupee exchange rate as also the current account deficit. Inflationary pressures are beginning to show in the market. The WPI hit a 4-month high at 3.18% in April. It could breach the 12-month high mark at 3.85 in May. The MPC works on inflation forecast one year hence and therefore has flexibility. But addressing inflation concerns is a priority and a interest rate hike is warranted.

Growth

The consistent increase in GDP Growth numbers at 5.3%,6%,7% and 7.7% in the last four quarters is a positive. It is a clear indication the Governments structural reform policies are paying dividends. Global Growth trends are favourable and normal monsoons augur well for the Indian economy. All of which provides the RBI some leeway to hike Interest rates.

Liquidity

The Credit to Deposit ratio of Indian Banks stands at 74% as of March this year, consistently falling since its post demonetisation November high. In other words, the Supply side surplus in Credit market is over and Demand pressures are on. Prompt Corrective Action is in full swing and 11 out of 26 PSU Banks are in its net. Their ability to lend is constrained, those not yet in PCA regime are cautious. Liquidity is a concern in the market.

Large corporates can still rely on the Bond Market for liquidity despite the high yields. SMEs are likely to be stressed. The Governments Fiscal Deficit breached the 2% mark last fiscal. Being the election year, the fiscal deficit will again be stretched. But the Government still has the Bond market to bail it out. All these factors favour a Rate hike.

Conclusion

All indications are for a rate hike by the MPC to curb Inflation. The index trends suggest that the market has already factored in the interest rate hike. The outcome of the MPC may well be a 25 BPS increase in the Repo rate. Alternately the MPC may put out a strong signalling communication of the imminent rate hike and follow it up with a hike of 25BPS in its August meeting. They should be doing the former rather than the latter to reduce uncertainty and put out a clear message.