It’s not difficult to make the case for a rate hike this time. Many of the upside risks that Governor Urjit Patel mentioned in his minutes have been materializing; rising crude prices, a high likelihood of increase in minimum support prices for crops, and an even higher likelihood of fiscal slippages.

There’s more. The 5% depreciation of the rupee year-to-date comes in the wake of many EM (emerging market) currencies slipping. Even if Argentina and Turkey are extreme examples, Indonesia’s double rate hike has raised the expectation that India, the other country with a current account deficit should do likewise.

A majority of the economists in CNBC TV18’s Monetary Policy Committee have asked for a rate hike looking at the sheer rise in core inflation, i.e. inflation excluding food and fuel. Core inflation jumping to 5.92% in April versus 4.9% five months ago in November raises the possibility of headline inflation following suit .

This once the mandarins of North Block will not object , though for different reasons. There the concern is that rising crude prices along with a depreciating rupee will make the landed price of crude too high for the consumer thus warranting an excise cut, which can unbalance the fiscal math. Hence the plea from North Bloc may be for a hike and no against one, so that a strong rupee keeps fuel prices manageable.

It is this chorus to one side that makes one fear that the RBI may land a hawkish hike, which could be a policy mis-step. Here’s why:

Firstly, the depreciation of the rupee is a good weakness. For the better part of 2017 the rupee was over valued by 21% in REER (real effective exchange rate) terms, and even after the depreciation of 2018 is overvalued by 15%. This overvaluation may partly be even responsible for the weak export growth and the rising current account deficit (CAD). Indian exports may be recovering with the GST disruption calming down, but they could still do with a weaker rupee. More importantly, the weaker rupee may be hurting domestic competitors from steel to engineering to consumer goods. Expensive petrol and diesel, will in fact introduce some optimizing of consumption.

Unfortunately a strong rupee is being seen in India as a strength and the government may well be targeted if the rupee touches 70, when that is exactly what the country probably needs. A rate hike may strengthen the rupee and benefit the wrong guys: the carry traders, the hot money FPIs. A strong rupee may hurt more than help India at this point.

Secondly, and may be more importantly, bond yields in India are already pricing in may be 3 rate hikes. Yields have moved up by about 130-140 basis points in 2018 alone. Near semi-sovereign PSUs like Nabard, NHB and SIDBI aren’t able to raise money given the free fall in bond prices.The bond market is completely moribund and the rise in credit offtake may be more replacement demand.

The psyche of the market is why buy now, when anyway one may have to provide for MTM (mark-to-market) losses in a few days. This fear can get exacerbated by a hawkish tone and won’t really help much needed growth.

The growth argument too as, most economists point out is overstated. The 7.7% GDP is more because of government spending and agriculture firing. Net of agri and public administration, growth actually slowed in the Jan-March quarter, from year ago levels, which was itself a weak quarter.

The hike, if any on June 6, will be coming after a four-and-a-half year gap. It will most certainly have some impact on the quality of some of the more aggressive loans lent by non-bank finance companies in the past year. An accident or two can’t be ruled out. Most banks have also raised lending rates last week. This too can have its impact on growth especially on MSME loans.

The RBI perhaps has to change from neutral to a tighter stance or hike rates, but need it do both? May be this once a hawkish pause or a dovish hike will serve better than a hawkish hike.

First Published:Jun 4, 2018 6:15 AM IST