Reserve Bank of India To Continue Hiking, INR Should Remain Firm

by Win Thin

Reserve Bank of India is expected to hiked rates by 25 bp at its regular meeting Tuesday.  Reverse repo rate is now 5.0% and the repo rate 6.0%.  This comes after RBI hiked rates 25 bp in September under the recent switch to more frequent meetings.  Usually, the RBI meets quarterly but the extended gap between meetings led to several intra-meeting moves this year and so the RBI now meets every 6 weeks instead of every 3 months.  Already twice this year, the RBI has hiked rates intra-meeting and then followed up with another hike at the next regular meeting.  RBI has also raised commercial bank reserve requirements this year, and more hikes there could be seen.  Inflation has stabilized, but remains at very elevated levels.  In September, industrial CPI rose 9.8% y/y (vs. peak of 16.2% y/y in January) while rural CPI rose 9.3% y/y (vs. peak of 17.4% y/y in January).  On the wholesale side, WPI rose 8.6% y/y in September.  The RBI said in a report this week that inflation remains above its “comfort level” and GDP growth surging, up 8.8% y/y in Q2 vs. 8.6% y/y in Q1, further tightening is warranted.

Despite the prospects of strong growth and higher interest rates, INR was in the middle of the pack for Asia EM in Q3, up 3% vs. USD.  The rupee is also in the middle of the pack so far in Q4, up 1% vs. USD.  The Finance Minister said recently that the government is comfortable with USD/INR between 43-45 and so for now, we see low risk of capital controls to counter strong rupee since it helps limit inflation.  Key level to look for ahead is around 44.00, which is the Oct 15 low and also the 62% retracement of the 2008-2009 rise in USD/INR.  Break would target the 2008 low around 39.20, but much will depend on overall EM appetite.  And any approach of 43 would get markets nervous about more restrictions on capital.  For now, EM FX remains largely range-bound as markets search for direction, but given the good numbers still coming out of China, we believe Asia will remain the star in EM and so we look for Asian currencies to continue gaining in Q4 and USD/INR is likely to test the bottom of that 43-45 range in the coming months.