Falling rupee poses new challenge to RBI MPC

The spectre of imported inflation through the falling rupee is a challenge before the Monetary Policy Committee of the Reserve Bank of India even as several analysts are banking on a rate cut in the February policy with the easing of retail inflation. 
 
The rupee fell to a record low of 86.59 against the US dollar earlier this week and expectations are that it could breach the 87 level by the middle of this year, if not earlier. Officials in New Delhi are understood to be concerned over the impact of the depreciating rupee on crude oil imports as well as a plethora of items that are imported including food items such as pulses and edible oils.
 
“The depreciation in the value of the rupee has been positive for exports but will also make imports more expensive,” pointed out an official source.
 
Analysts also point out that theoretically, core inflation could rise due to the rupee depreciation and the recent escalation in global crude oil prices. According to estimates by Nomura, every 5% depreciation adds about 0.26 percentage points to headline inflation and about 0.1 percentage point to core inflation.
 
Retail inflation in December eased to a four month low of 5.22% and food prices saw some marginal cooling. The MPC, chaired by the new RBI Governor Sanjay Malhotra, is scheduled to meet between February 5 and 7 and analysts expect a 25 basis point cut in the repo rate in the backdrop of easing retail inflation and slowing growth to an estimated 6.4% this fiscal.
 
“Currency weakness has worsened the policy tradeoffs. We expect the RBI to follow amore orthodox flexible inflation-targeting monetary policy framework. If inflation is near target despite currency weakness, and growth is below trend, then we would expect the MPC to support growth. Hence our call for a 25 basis point repo rate cut in February,” Nomura said in a recent note adding that it expects 100 basis points in cumulative rate cuts in 2025.
 
However, in a note earlier this month, Standard Chartered said it has pushed back its call for 50 basis points of repo rate cuts to April-June from February-April. It has also revised its 2025 USD-INR forecast, given increased external-sector volatility, evidence of the Reserve Bank of India’s (RBI’s) higher tolerance of a stronger USD, and tighter banking-system liquidity. “We revise our USD-INR forecasts to 86.25 by March 2025 (84.50), 86.75 by June (85.0), 87.25 (85.25) by September and 87.75 (85.50) by end-2025,” it said.

Published on: Jan 16, 2025, 4:13 PM IST