The repo rate is the interest rate at which the RBI lends money to all commercial banks.

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The next monetary policy meeting is scheduled for the first week of April 2023.

At the latest Monetary Policy Committee (MPC) of the RBI in early February, it decided to raise the repo rate by 25 basis points to 6.5 per cent to keep inflation expectations anchored, break the persistence of core inflation, and strengthen the medium-term growth prospects.

Raising interest rates is a monetary policy instrument that typically helps suppress demand in the economy, thereby helping the inflation rate decline.

In early 2020 when Covid hit the world, the repo rate was 4 per cent.

“The (RBI’s) stance could continue to be withdrawal of accommodation, even as liquidity is now in deficit mode. RBI can always keep the options open in June (monetary) policy,” the SBI Research, authored by Group Chief Economic Adviser State Bank of India Soumya Kanti Ghosh, said.

The report asserted that the RBI has enough reasons to pause the repo rate hike in the April meeting.

“There are concerns of a material slowdown in the affordable housing loan market and financial stability concerns taking centre stage. While concerns on sticky core inflation is justified, it may be noted that average core inflation is at 5.8 per cent over the last decade and it is almost unlikely that core inflation could decline materially to 5.5 per cent and below as post-pandemic shifts in expenditure on health and education and the sticky component of transport inflation with fuel prices staying at elevated levels will act as the constraint. By this logic, RBI may then have to go for more rounds of rate hikes,” it explained in the report.

Notably, retail inflation in India fell marginally but remained above RBI’s 6 per cent upper tolerance band for the second straight month in February 2023, with the Consumer Price Index pegged at 6.44 per cent. In January, the retail inflation was 6.52 per cent.

India’s retail inflation was above RBI’s 6 per cent target for three consecutive quarters and had managed to fall back to the RBI’s comfort zone only in November 2022. Under the flexible inflation targeting framework, the RBI is deemed to have failed in managing price rises if the CPI-based inflation is outside the 2-6 per cent range for three quarters in a row.

On India’s inflation, the Ecowrap report forecast March and April to be 5.5-5.6 per cent and 4.7-4.8 per cent.

“Thus, the RBI will have a delicate balancing job of either looking forward to the June meeting with clear signs of inflation trending downwards or looking backwards at the Jan and Feb prints in April policy. Thus, it will be a delicate choice (for RBI),” the report said.

Not just India, US monetary policy committee too is on an interest hike spree in the fight against inflation.

The US monetary policy committee, seeking to achieve maximum employment and inflation at the rate of 2 per cent over the longer run, hiked the key interest rate by 25 basis points to over a 15-year high of 4.75-5.0 per cent at its latest two-day review meet last week. The latest hike was the same size as its previous rate increase in the February meeting and marked its ninth straight rate hike.

The hike comes amid the dilemma faced by its central bank on inflation targeting and on maintaining banking sector stability – the former is way above target and the latter is shaky after the recent collapse of a couple of banks and the contagion effect on others.

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Meanwhile, consumer inflation in the US moderated in February to 6.0 per cent from 6.4 per cent the previous month, but the numbers are still way above the 2 per cent target. It was at 6.5 per cent in December, and 7.1 per cent the month before.

“Fed rate hikes could be smaller in magnitude, and one last in May policy of 25 bps,” SBI Research said.

“The challenge is now to decouple from Fed. But the good thing is that a dovish Fed means soft dollar and thus lower depreciation risk for the Indian rupee in the short to medium term,” it added.

Barclays Plc expects the gap in current account — the broadest measure of trade in goods and services — to be 1.8% of gross domestic product in the year starting April 1, after previously cutting it to 1.9% from 2.3% deficit it had estimated in mid-February. Citigroup Inc. slashed its forecast even further to 1.4% of GDP from 2.2%, reflecting a steady drop in goods imports and strength in services exports.

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The lower prints will provide a tailwind to the rupee, which is vulnerable to a selloff, given the twin deficits in the nation’s budget and current account make it more reliant on foreign inflows. A narrowing shortfall will also take the pressure off the central bank to sell foreign exchange from its reserves to stabilize the currency and check imported inflation.

“We are encouraged by the fact that the narrowing of the trade deficit has sustained and services exports remain strong,” said Ashish Agrawal, head of foreign-exchange and emerging-market macro strategy research at Barclays in Singapore. “The lower current account deficit reduces dependence on financing flows and RBI’s dollar sales at the margin.”

That’s an added positive for the rupee, which along with Asian peers gained against the dollar after a dovish interest-rate hike by the Federal Reserve. The rupee was up 0.2% to 82.30 to a dollar on Monday.

Services Surprise

What seems to have caught economists by surprise is the strong services exports print.

Services trade surplus was strong at $14.6 billion in February, building on January’s revised surplus of $13.8 billion. Services exports nearly touched $30 billion in both January and February, an increase of about 40% on-year.

HSBC Holdings Plc attributes a part of this rise to Global Capability Centres set up by large multinational corporations. India is home to about 40% of global GCCs, and this ratio is only expanding as they rise in scope, an HSBC report said.

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“Services trade surplus is truly a hero in India’s foreign trade story right now,” said Dhiraj Nim, an economist and forex strategist at Australia and New Zealand Banking Group, who is confident the trend will continue.

Barclays expects the improving external sector fundamentals and relatively cheap valuations to help the rupee rally later as the dollar weakens. But most remain cautious amid global volatility and the Reserve Bank of India’s aim to build back reserves at every opportunity.

From the current account perspective, this augurs well for the rupee, said Madhavi Arora, lead economist at Emkay Global Financial Services Ltd. That said, the global situation is extremely fluid and could adversely impact global risk appetite for risk EM assets, including the rupee — emerging Asia’s worst performing currency last year and among the bottom this year.

“Thus the capital account side also needs a watch,” she said.