Run up to monetary policy: Hawkish stance to weaken rupee

RBI governor Raghuram Rajan said that fighting inflation would continue to be a top priority for central bank

It is widely expected at its second bi-monthly policy review on June 3, the Reserve Bank of India (RBI) will maintain status quo on the policy rate. In case the central bank adopts a hawkish stance, it is likely the rupee will weaken, though bond markets might remain range-bound.

Market participants say a hawkish stance could dim any possibility of a rate cut in the near future. This will hit inflows, a key determinant of the direction of the domestic currency.

After growth in gross domestic product hit a decade-low in the last financial year, India Inc has been clamoring for a rate cut to boost economic activity.

On Tuesday, RBI Governor Raghuram Rajan said fighting inflation would continue to be the central bank’s priority. He, however, added RBI would aim to strike a balance between growth and inflation.

“The market has factored in status quo in key policy rates and a hawkish stance by RBI, owing to which the yield on the 10-year bond might rise by five basis points on that day. The rupee might depreciate about 30 basis points if the hawkish stance is maintained,” said Ashutosh Khajuria, president (treasury), Federal Bank.

Experts say the fall in the rupee against the dollar is likely to continue because RBI is intervening in the market, buying dollars to boost foreign exchange reserves. Latest data show during the week ended May 16, the central bank’s foreign exchange reserves rose by $1.09 billion to $314.93 billion. The reserves have been consistently rising for some time.

This year, the rupee has risen about five per cent. Currency dealers said the appreciation would have continued due to the fact that the country’s current account deficit narrowed, had the RBI not been buying dollars.

“If RBI’s forecast is hawkish, it shows growth might continue to be a concern and this impacts fund flows into the country. Due to this, the rupee might weaken on that day. Similarly, though the market has discounted a hawkish stance by RBI, yields might move up by five basis points,” said the head of treasury of a state-run bank.

On Tuesday, the yield on the 10-year bond closed at 8.67 per cent, compared with the previous close of 8.68 per cent. The rupee ended at 59.04/dollar, against the previous close of 58.72/dollar.

Though short-term rates aren’t seen changing substantially from current levels, as these are functions of liquidity in the system, a rise or cut in the repo rate will impact these. Currently, the repo rate stands at eight per cent; it was kept unchanged in the first bi-monthly monetary policy in April.

Moses Harding, group chief executive officer (liability and treasury management) and chief economist, Srei Infrastructure Finance, said, “RBI’s focus will continue to be on retail inflation, but signals on the way forward might not be hawkish, given the immediate need for the new government to restore animal spirits to spur economic development.”