The monetary policy committee (MPC) of India's central bank surprised market watchers by keeping interest rates unchanged, in a development that will have consequences for the already-deepening turmoil in currency markets.
The MPC, in its report, has said headline inflation is expected to accelerate to 4.5 per cent by March 2019 quarter with upside risks. Market is reacting strongly to Brent crude movements and with current pace 75 can likely be seen if crude touches 88-90 levels. This comes after MPC raised the benchmark repo rate twice this year, taking it from 6 percent to 6.5 percent.
All of this has resulted in currency depreciations in emerging economies, which is an understatement as far as the rupee is concerned. While inflationary expectations for the three months ahead rose sharply by 50 basis points, a year down the line those expectations were lower by 30 basis points compared to the survey in June.
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Following the fourth bi-monthly monetary policy committee (MPC) meeting, the central bank changed its projection on the back of an unusually benign trend in food prices.
The fact that higher interest rates will compound the liquidity problem was a setback for the consensus view on the RBI policy.
So far this calendar year, the rupee has been Asia's worst performing currency as it has fallen nearly 15 per cent.
Consistent dollar demand from importers following higher crude oil prices, kept the rupee under pressure. Despite domestic inflation running in double digits in 2013, they only lifted the policy rate twice by 25bp in September and October 2013. "With the USA yield inching up to 3.25 percent, it was expected the RBI would increase the rates to protect against the inflation rise". As things stand, inflation is expected to touch 4.5% by the end of the current fiscal year. "Given the rising oil and trade tensions, traders will bet on exports going up, to curb further weakening in the currency", said Anand James, Chief Market Strategist at Geojit Financial Services.
So while inflation in India is rising it's being driven by external factors, rather than strength in the underlying economy.