Plunging Indian rupee raises bets on unexpected rate hike

The central bank of India may keep its benchmark interest rate unchanged at Friday’s monetary policy meeting, contrary to expectations that it would do so.

A majority of economists surveyed by CNBC expect the Reserve Bank of India to keep interest rates unchanged at 5.25%, while suggesting a rate hike may only occur towards the end of the year.

Few expect policymakers to act at this week’s meeting to sustain the rupee, which has fallen to record lows against the dollar.

CNBC conducted a poll of nine economists last week ahead of the RBI’s policy decision.

But Venugopal Ghale, managing director and head of India research at Bernstein, told CNBC Inside India on Tuesday that it would be “more logical” for India’s central bank to take a different tack and raise interest rates.

He added that the rate hike would bring India in line with “the movements in global interest rates in recent weeks” and could curb capital outflows at a time when “weak currencies have been the biggest pain point for policymakers.”

In some cases, India’s regional countries are doing more than expected to stay ahead of the inflation curve.

Like India, Indonesia has been suffering from currency depreciation, and on May 20, the country’s central bank raised interest rates by a higher-than-expected 50 basis points. On May 26, the Central Bank of Sri Lanka raised its policy interest rate by 100 basis points, the largest increase in four years.

India’s currency has been under pressure from soaring import prices and persistent capital outflows, with Prime Minister Narendra Modi even urging people to help save foreign currency.

Policymakers are also taking actions to protect the struggling rupee, including selling dollars through state-run banks to stem its decline, Reuters reported. The government also raised tariffs to curb gold demand with the aim of preserving foreign currency.

The rupee remains one of Asia’s most vulnerable currencies, even as it has strengthened from record lows and moved closer to the psychologically important 100 points against the dollar.

Referring to exchange rate fluctuations, central bank governor Sanjay Malhotra said in an interview with news website Mint on May 25 that the central bank will “do whatever is necessary to ensure orderly price discovery in the foreign exchange market.”

Although Mr. Malhotra did not explicitly say that raising interest rates was on the table, his comments suggested that currency and bond markets were preparing for bolder action with all options on the table.

Another factor that may favor the RBI to cut interest rates is the risk of higher inflation.

India’s inflation rate remains below the RBI-mandated 4%, but some economists believe a combination of inflationary pressures from rising energy costs, a weak currency and weather-related crop shortages could force the RBI to take pre-emptive action.

Sakshi Gupta, chief economist at , said “higher energy costs that are passed on to retail consumers” and “weather-related disruptions from this year’s El Niño” are creating new risks to the future trajectory of inflation. HDFC Bank.

In April, India’s consumer price inflation rate rose for the sixth straight month to 3.48%, even though the government kept prices stable.

But over the past two weeks, the government has increased fuel prices several times, which could lead to a sharp rise in inflation.

The brokerage raised its average inflation forecast for the fiscal year ending March 2027 to 4.9% from 4.6%, after the cumulative increase in fuel prices was 7.5 rupees ($0.08) per liter, higher than Citi’s base assumption of 5 rupees.

“We still expect interest rates to remain unchanged at the June MPC,” the brokerage said in a note on Saturday, referring to the central bank’s Monetary Policy Committee, but added that it expected two hikes of 25 basis points each in August and October.

If El Niño forecasts are unfavorable, the RBI may be forced to raise its inflation forecast and raise interest rates sooner rather than later. El Niño refers to the natural rise in sea surface temperatures that occurs every few years. The Reserve Bank of India warned at its April meeting that El Niño could pose a threat to inflation.

These predictions are now even more dire.

“There is 90% certainty that El Niño will be on our doorstep in the coming months,” United Nations Secretary-General António Guterres said in a statement on Tuesday. He added that the world needed to treat this as an “urgent climate warning” and warned that “the impacts will be even more severe.”

Meteorologists have lowered their forecast for India’s monsoon this year, predicting rainfall will be 90% of the long-term average, according to multiple local media reports.

This is lower than the 92% forecast released in April and would be the worst monsoon performance in 11 years. India is already experiencing a severe heatwave, and nearly 60% of its agriculture depends on rainfall.

Food inflation, a key component of India’s consumer price index, rose 4.2% in April from 3.87% in March.

Maximo Torello, chief economist at the Food and Agriculture Organization of the United Nations, said that in addition to India’s food production woes, the country was facing fertilizer shortages ahead of the crucial kharif sowing season.

“If the crisis (Gulf conflict and below normal monsoon) is prolonged, India will face higher import costs, reduced domestic fertilizer availability and food inflation pressures, especially in wheat, rice and vegetables,” he said in a report published on news agency website ANI on April 22.