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Goldman Sachs says the Reserve Bank of India (RBI) may hike rates three times by the end of 2018, as the Rs 2.11 lakh crore bank recpitalisation exercise would spike up short-term rates and core inflation. One thing is clear now that most analysts no longer expect any rate cut by the central bank after inflation inched up nearly 200 basis points, or two percentage points, between June reading (1.46 per cent) and that of August (3.36 per cent). The monetary policy committee (MPC) resolution, and the subsequent minutes also clearly portray how five of the committee members, including governor Urjit Patel, are concerned by the rise in inflation. Only Ravindra Dholakia, an external member of the committee, is still persistent with his rate cut demand. But he has also toned down such demands. Earlier, he was rooting for at least 50 basis points cut, but now he has settled for a 25 basis points cut. Other MPC members are not in the mood for a cut. “We have to be vigilant on account of uncertainties on the external and fiscal fronts; this calls for a cautious approach,” the recent minutes quoted Patel as saying. RBI’s executive director Michael Patra was outright hawkish on his assessment. “The primary objective of the monetary policy enjoined by the RBI Act is challenged and the credibility of the MPC will be tested in the months ahead,” he said. These statements leave out any hope of a rate cut and the 10-year bond yields had appropriately risen 20 basis points to 7.75 per cent since the publication of the minutes, even before the bank recapitalisation was announced on Tuesday after market hours. The recap plan has pushed the yields further up a few basis points more as market expects fiscal deficit to widen and more supply of bonds to come. Therefore, not many, except industry lobby group and a few die-hard believers in 25 basis points rate cuts pushing up growth sharply would expect a cut from this point, caeteris paribus. Goldman Sachs seem to be betting that the hikes would be much sharper and not gradual.
By giving a call of three hikes, the brokerage essentially is saying by the end of 2018, rates would go up by 75 basis points, “an outcome that is not fully priced in by the market,” it said in its 25th October report.The consensus now is it would be an extended pause before rates start inching up, but nobody is sure about the timing. Goldman Sachs said RBI would go for hikes, “should growth momentum improve substantially, reducing economy-wide slack, and core inflation inch higher.” What would probably push up the economy? Goldman Sachs has this to say: “… if the banking system leverage ratio remains constant, the capital infusion could lower the drag on bank credit growth by up to 10 percentage point and boost GDP growth by up to 5 percentage point, adding upside risk to our real GDP growth forecasts for the coming years.” But the whole idea of putting the recap money is so that banks take care of their provisioning need, leverage the balance money multiple times and push up credit growth. That’s how credit growth increases. So, the assumptions of Goldman Sachs sound a bit contradictory, pointed out an economist with a private bank who did not wish to be named. While the economist does expect rates to be hiked by the end of 2018, it may not be three times. And that’s also the consensus as aggressive rate hikes would be needed only when the economy overheats. The chances of economy going full steam are still not that great, considering the bank capitalisation would largely take care of the bad apples in the book. And all said and done, capacity utilisation of the industry is still constant at around 72-73 per cent for many quarters and that’s unlikely to change very soon.