Chief economist update: An Indian surprise

Just when we thought the times of central bank surprises were things of the past, the Reserve Bank of India (RBI) brought them back.

The RBI kept interest rates unchanged - repo rate at 6.5%, reverse repo rate at 6.25% - at the conclusion of its October 5 board meeting, following a 25 bps increase at its previous meeting on August 1.

The RBI's decision defied consensus expectations for a follow-up rate hike wherein which, according to a Bloomberg poll ahead of the decision, only nine out of 49 respondents called for no change in interest rates.

These predictions were based on sharply rising inflation expectations.

To be sure, the country's inflation rate remains below the mid-point of the RBI's 4% (+/-2%) target - down for the second consecutive month to 3.7% in August from 4.2% in July and 4.9% in June.

But that's old stats. The precipitous slide in the Indian rupee this year would exert upward pressure on India's inflation. The Indian rupee ended at an all-time low of R73.85 to the US dollar at the close of last week's trading - after hitting R74.22 in intra-day trade and is now 13.6% down versus the greenback this year to date.

The rupee's depreciation would aggravate the upward push in India's inflation caused by rising oil prices - the price of Brent oil has risen by 24% between January and September this year - because of the country's dependence on oil imports.

According to Bank of America Merrill Lynch currency strategist Rohit Garg: "In terms of oil impact, we believe 10% rise in oil causes headline inflation to move higher by about 0.6%."

However, the Indian central bank doesn't seem perturbed and even lowered its inflation projections:

"Inflation is projected at 4.0 per cent in Q2:2018-19, 3.9-4.5 per cent in H2 and 4.8 per cent in Q1:2019-20, with risks somewhat to the upside. Excluding the HRA impact, CPI inflation is projected at 3.7 per cent in Q2:2018-19, 3.8 - 4.5 per cent in H2 and 4.8 per cent in Q1:2019-20."

The RBI lowered its GDP growth projections slightly: to 7.4% from 7.5% in Q2:2018-2019; to 7.1%-7.3% from 7.3%-7.4% in H2; and, 7.4% from 7.5% in Q1:2019-2020.

This is likely given that the rupee's depreciation would make Indian exports cheaper in the world market and hence, make its exports more competitive. But as the RBI notes:

"Tailwinds from the recent depreciation of the rupee could be muted by the slowing down of global trade and the escalating tariff war".

Read more: Reserve Bank of India
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