Reserve Bank is likely to keep repo rate unchanged at 6 per cent for the third straight time in the upcoming policy review, says a report.
The Monetary Policy Committee (MPC) will meet on February 6 and 7 and the outcome will be announced on Wednesday.
"Its almost a given that the RBI will hold the repo rate steady when it concludes this week's policy meeting. The upside risks to inflation in the coming quarters suggest that the RBI will have to lift the policy rate eventually, but not just yet, particularly if it does not want to kill the nascent economic recovery," BNP Paribas said in a report today.
The report said inflation in FY18 seems to be benign enough,averaging 3.7 per cent but in the next financial year it expects headline CPI to rise to 4.8 per cent - within the upper half of RBIs 4-6 per cent target range.
It said in the policy investors will look for how the RBI responds to the ongoing sell-off in the government bond market. Last Friday saw the bond market whipsaw, initially selling off on slightly larger-than-expected fiscal slippage, then rallying on hopes that the RBI might buy bonds or expand foreign investor limits. However, the cheer proved short-lived, it said.
The report said RBI bond purchases would not only provide the market some succour, but also provide support to the economy.
The risk, of course, is that markets might construe RBIs bond purchases as being made at the behest of the government, it said.
"Central bank independence aside, there is also the issue of moral hazard should the RBI really act as a back-stop to support a bond market that is in part selling off because of the governments inability to reach its own fiscal targets?" the report questioned.
These are not insignificant considerations that, as the RBI has learnt from previous experience, have the potential to hurt its credibility and independence over the longer term, it said.
The report said given these risks, it would be surprised if the RBI makes an explicit commitment to purchase government bonds this week.
"If it is looking to relieve some of the pressure on the bond market, a lifting of the limits on yield-hungry foreign investors might make more sense," it said.
With bond markets wobbly, the RBI will have to strike a careful balance in its rhetoric, the report said.
It, however, continued to forecast two 25 basis points rate hikes in the second half of 2018, taking the repo rate to 6.50 per cent by the year-end.