RBI policy review: Why economists predict Rajan will keep rates steady on Tuesday

India’s hawkish central bank is likely to keep its key interest rate unchanged on Tuesday as inflationary pressures have started to ease, economists told Forbes India.

Most economists say the Reserve Bank of India will prefer to watch the outcome of the national elections and the new government’s budget, before deciding on whether it needs to raise or cut interest rates.

India’s inflation has been volatile but started to taper off from its late-2013 highs. Wholesale prices rose 4.68 percent in February as food and fuel prices slowed while consumer price inflation eased to an over-two-year-low of 8.10 percent, which is close to the 8.0 percent target set by an RBI committee led by deputy governor Urjit Patel.

“We expect the bank to keep rates on hold. Even as inflation is moderating gradually, the RBI would prefer to see if a stable government and budget come through and then decide if it needs to alter rates,” Shubhada Rao, chief economist with Yes Bank told Forbes India.

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The benchmark repo rate, at which the RBI lends to commercial banks, is at 8.0 percent and the cash reserve ratio - the amount banks need to keep aside to withstand financial shocks, stands at 4.0 percent.

The RBI governor Raghuram Rajan - who has warned about taking unpopular steps to tame stubborn inflation - has hiked interest rates thrice since taking charge in September last year, often catching economists and the media wrong-footed.

India’s stock markets are at a record high as foreign investors are betting that the Bharatiya Janata Party, widely seen as a business-friendly, could emerge as the winner.

India’s macro-economic conditions, including the rupee, have also started to improve. Industrial output edged up by 0.1 percent year-on-year in January, snapping three months of declines.

India’s current account deficit – which stems mainly from huge oil and gold imports and weak exports amid the global economic downturn – hit a record 4.8 percent of GDP in the fiscal year to March 2013 and caused obvious discomfort to foreign investors.

The deficit had narrowed to 0.9 percent of GDP in the quarter ended December of the current fiscal year, after the government kick-started measures to reduce imports of non-essential items, such as gold.

The RBI had raised rates in September and October last year and in January 2014, saying it was determined to fight inflation, but government and business leaders continue to clamour for a looser monetary policy to help spur a sharply slowing economy.

India Ratings, a Fitch Group firm, in a report last week has warned that any further increase in interest rates could increase the number of companies which face financial stress.

Credit quality pressures have persisted for Indian companies, due to generally sluggish demand, tight liquidity and high interest rates.

Siddhartha Sanyal, chief India economist with Barclays Capital said: “Rates are likely to be on hold at present. After the electoral uncertainty clears, the RBI can then take a longer-term view.”

It would by then also have more clarity on the progress of the monsoons, Sanyal said.

The scandal-tainted Congress-led government is desperate to tame inflation and revive the economy as it seeks a third term in office after national elections, voting for which starts on April 7.

India posted growth of 4.7 percent in the third quarter ended December, from 4.8 percent in the second quarter, far below the near double-digit expansion enjoyed when the economy was booming.

The author writes for Forbes India