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MOSL: ECOSCOPE-Why the RBI should avoid further rate hikes; Domestic fundamentals do not warrant a rate hike

ECOSCOPE: Why the RBI should avoid further rate hikes; Domestic fundamentals do not warrant a rate hike

 

• The bond market appears to have given its verdict. Over the past six weeks, the 10-year benchmark bond yield has increased from 7.70% to ~8.15%, implying that the most powerful market has moved on from “Whether RBI will hike rates next month?” to “By how much will RBI hike rates?” A rate hike of 25 basis points (bps) has almost become a consensus, and now talks of a 50bp hike are slowly gaining momentum. We, however, believe that the RBI should avoid further rate hikes.
• There are two reasons forwarded for rate hikes – higher core inflation and a weakening Indian Rupee (INR). However, we argue that a rate hike would be broadly ineffective to address these concerns. While headline inflation has consistently surprised on the downside, the drivers of so-called core inflation are largely rate-inelastic. Further, higher core inflation is driven by a very few components and more than 90% of the CPI basket (excluding ‘vegetables’ and ‘fuel’) is at 4.4% inflation. We, thus, believe that concerns about higher core inflation are overstated.