Year 2013: The unexpected reversal of interest rate cycle

The repo rate may end at a level where the year had begun, at 8%

The year which is about to end in few days marks the reversal of an interest rate cycle which was not expected by many economists. The repo rate or the rate at which banks borrow from the Reserve Bank of India (RBI) may end at 8%, a level where it stood at the beginning of the year. 

 

At the start of the year most economists had expected repo rate cuts of 100 basis points which would have taken the rate to 7%. But due to concerns on the inflation front as well as the Indian rupee, the cuts were limited to 75 basis points till May 3 followed by a reversal beginning the first monetary policy review under the governorship of Raghuram Rajan on September 20.

 

The repo rate currently stands at 7.75% and the street expects a further rise of 25 basis points on Wednesday in the mid-quarter review of the monetary policy. The blame is on the double digit Consumer Price Index (CPI) inflation numbers which rose to 11.24% in November compared with 10.17% in the previous month. The Wholesale Price Index (WPI) inflation data for November is expected on Monday which shall provide further direction to the monetary policy expectations of the street.

 

“The RBI flagged that inflation had been the key trigger for them to start hiking rates since September. The Indian rupee weakened significantly against the dollar on a y/y basis, even after the pullback in more recent months. Realigning interest rates in India with global interest rate cycles might be a consideration for the RBI as well,” said Siddhartha Sanyal, chief India economist, Barclays. Sanyal had expected 100 basis points cut in the repo rate in 2013.

 

The rupee which tumbled down to touch an all-time low on August 28 at Rs 68.85 per dollar was not foreseen. “Despite growth being a concern with inflation remaining significantly stubborn for most of the year, the policy stance had to shift and calibrate in terms of addressing inflationary expectations. A large part of this inflation came from supply constraints. In addition, RBI mounted interest rate defence in order to impart stability to highly volatile currency. A hint of taper from the Fed Chairman by end-May, along with our external sector vulnerability through widening of current account deficit to unsustainable levels, prompted the central bank to squeeze domestic liquidity and maintain higher interest rates,” said Shubhada Rao, chief economist, YES Bank. Rao had also expected a 100 basis points cut in the repo rate at the start of 2013.