RBI to hold key rate due to rise in inflation: Morgan Stanley

Retail inflation rose to 5-month high of 3.36% in August due to costlier vegetables and fruits

The Reserve Bank of India (RBI) is likely to hold the key rate in the monetary policy review next month following a jump in inflation and is expected to focus more on resolving the problem of bad loans in the banking system, says a Morgan Stanley report.

There was an uptick in headline inflation in August driven by implementation of the House Rent Allowance (7th Pay Commission) hike and accordingly the RBI is expected to keep rates on hold, said the financial services major.

Retail inflation rose to 5-month high of 3.36 per cent in August due to costlier vegetables and fruits. The consumer price index (CPI) based inflation was 2.36 per cent in July.

"Against this backdrop of rising headline and core inflation, we think that this print would not give RBI the comfort to cut interest rates at its October meeting," Morgan Stanley said in a research note.

RBI reduced the repo rate by 0.25 per cent to 6 per cent in August, citing reduction in inflation risks. The rate cut was the first in 10 months and brought policy rates to a near seven-year low.

"This acceleration was 20 bps higher than what we and consensus had expected. The acceleration in headline inflation was driven by increases in food prices and core inflation alike," Morgan Stanley said.

It forecast the September CPI inflation at around the 3.3 per cent as favourable base effects fade from food inflation.

"We believe that RBI's focus will shift back towards the resolution of non-performing loans in the banking system for reviving credit demand and the investment cycle, rather than further rate cuts," it said.

The banking sector is saddled with NPAs of over Rs 8 trillion (Rs 8 lakh crore), of which Rs 6 trillion is with public sector banks (PSBs).