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RBI may have to hike rates by 50 Basis points to prevent Rupee rout.

Date: 07-09-2018
Subject: RBI may have to hike rates by 50 Basis points to prevent Rupee rout
MUMBAI: In a re-run of the 2013 taper tantrum, emerging markets across both hemispheres have been roiled in the past few weeks, triggering rate increases in economies vulnerable to capital flight. Until now, India has resisted the temptation to join peers Argentina or Indonesia in enhancing the cost of funds, but may now raise rates 50 basis points this year to prevent a currency rout. 

Meanwhile, the rupee hit another record low at 72.11 Thursday, extending its losses for the eighth consecutive day. It lost 0.32per cent to close at 71.99 to a dollar. The benchmark bond yield was a tad up at 8.06per cent Thursday. 

The Overnight Interest Rate Swap, a derivative gauge where investors exchange fixed rates for floating, has risen to nearly a three-year high, signaling that the central bank may raise rates in two back-to-back policy meetings in October and December. 

The gauge with one-year maturity hit as high as 7.30per cent, the highest in nearly three years. It surged 35 basis points in just the past three-four weeks. 

“This is an indication that people are expecting further rate increases with the drastically falling rupee,” said Ashutosh Khajuria, executive director and CFO of Federal Bank. “Increased interest rates will attract global investors in debt papers, bringing in foreign currency flows.” 

To be sure, India’s domestic-centric economy is far less exposed theoretically to global trade shocks than, say, Indonesia, Argentina, and Turkey, which rely on a narrow range of commodities and are more prone to external business cycles. 

“India’s economy is certainly not comparable to those of Turkey and Argentina in terms of macro parameters like forex reserves, GDP or fiscal deficit,” said Khajuria. 

Interest rates in Argentina are as high as 60per cent as the local central bank has tried to control inflation running at more than 31per cent. Both Turkey and Argentine are the two worst-performing emerging market currencies that have triggered global capital flight to dollar-backed assets. 

“The rupee’s drastic fall has raised expectations of interest rate rises,” said Suyash Choudhary, head of fixed income at IDFC MF. The local unit’s losing value may lead to higher liquidity in the system, which is inflationary, a key factor for the Monetary Policy Committee. 

“The money market is building expectations of interest rate increases of at least 50 basis points in the next two consecutive policies,” he said. 

India’s economy expanded at 8.2per cent in the April-June quarter this year, the highest in about two years, amid signs of economic prosperity. 

“With stronger GDP and a losing rupee, we expect the RBI to raise rates in a measured manner,” said Vijay Sharma, executive vice president for fixed-income at PNB Gilts. “Unlike other emerging markets where interest rates have been raised sharply, the central bank is unlikely to go for any sharper pace of rise.” 

Short term interest rates have already started moving up. The 364-day Treasury bill yielded 20 basis points higher in the primary market at 7.52per cent compared to last week’s  Sale.

Source: economictimes.indiatimes.com

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