Weeks after the first rate hike in this cycle, in an interview to a TV channel in May, Reserve Bank of India (RBI) Governor Shaktikanta Das had said expectations of a rate hike were a no-brainer, hinting that there would be more over time.

If Das gives another interview now, ahead of the meeting of the central bank’s rate-setting body, the Monetary Policy Committee (MPC), he would say the same thing.

Since May, the RBI has raised its policy rate — called the repo rate, or the rate at which commercial banks raise money from the central bank — thrice, from its historic low of 4 per cent to 5.40 per cent, and shifted its focus from growth to fighting inflation in the world’s fifth-largest economy.

This week, the MPC will go for yet another rate hike. And, it would not be a 25-basis points (bps) hike, for sure. It could be either 50 bps or 35 bps. One bps is a hundredth of a percentage point.

First, why should there be a rate hike?

As Das had said, it’s a “no-brainer”. Retail inflation rose 7 per cent in August. After peaking at 7.79 per cent in April, there was a gradual slowdown in the rate of rise till July, when inflation rose 6.71 per cent.

From January, when it had breached the upper band of the RBI’s flexible inflation target (4 per cent +/- 2 per cent), inflation remained above the level for eight straight months. If it breaches the 6 per cent upper band for nine months in succession — which it will — the RBI owes an explanation to the government.

Since August 5, when the RBI raised its policy rate by 50 bps, barring China, Turkey and Russia, most central banks across the globe, in developed as well as emerging markets, have raised policy rates to combat rising inflation. (China, Turkey and Russia have cut rates.)

While the European Central Bank, Bank of Canada, Bank of France, Deutsche Bundesbank (the German Federal Bank), the central bank of Sweden and Swiss National Bank have raised the rate by 75 bps each, the central banks of Chile and Hungary have raised it by one percentage point. Among others, the Bank of England, the Reserve Bank of Australia and the Reserve Bank of New Zealand have raised the rate by 50 bps each and those of Indonesia, Poland, Nigeria, Thailand, Korea and Malaysia by 25 bps each.

For India, what matters the most is the US Federal Reserve rate. Last week, the Fed raised the policy rate by another 75 bps to a range of 3-3.25 per cent – the highest since early 2008.

Since the RBI is determined to ensure a soft landing for the economy by frontloading the rate hikes, there’s no escaping yet another hike. But, how much will it be?

Those who have been rooting for a 35-bps rate hike, taking the policy rate to 5.75 per cent, justify their argument on a few critical factors.

Assuming a normal monsoon and average price of Indian basket crude at $105 per barrel, the August MPC meeting had stuck to the June inflation projection of 6.7 per cent for FY2023. It had fine-tuned the projection for the second and third quarters, but left the fourth quarter estimate unchanged at 5.8 per cent with risks evenly balanced. For the first quarter of FY24, the retail inflation projection is 5 per cent.

Inflation is unlikely to overshoot the RBI estimate, particularly when the crude prices are down substantially, even below their level before the Russia-Ukraine war started. In fact, it could be even less than what the central bank had projected.

Besides, the growth story is not that exciting at this point. India’s GDP has grown at 13.5 per cent in the first quarter of FY23, at the quickest pace in a year, but much below the RBI’s projection of 16.2 per cent. Most multilateral agencies and global raters have paired the Indian economy’s growth estimate for the year. Meanwhile, the industrial output grew by just 2.4 per cent in July — the lowest since April — from 12.7 per cent in June. Hence, the RBI can’t afford to be too aggressive in raising the policy rate.

But I belong to the group that expects yet another 50-bps rate hike.

Indeed, the price of the Indian basket of crude has fallen below the RBI’s estimate, but the monsoon has been uneven and food inflation is a big threat. A depreciating rupee will also offset the gain of undershooting the oil price projection. The RBI is unlikely to revise its inflation projection downwards.

A 75-bps rate hike by the Federal Reserve has been in sync with expectations, but what has queered the pitch for the RBI is Fed’s median forecast that the policy rate can go as high as 4.6 per cent in 2023 before the central bank stops its fight against soaring inflation. The forecast also shows that the Fed may hike the rate to 4.4 per cent by the end of 2022. With only two policy meetings left in the calendar year, another 75-bps rate hike before the year-end is a high probability.

The dot plot, which signals Fed’s outlook for policy-rate path, shows six of the 19 “dots” would take rates even higher — to a 4.75-5 per cent range next year.

Since 2000, the mean or average difference between the US Fed rate and India’s policy rate is 528.86 bps. The difference or spread was the highest, 900 bps, in August 2000 when India’s policy rate was 15.5 per cent (it was called reverse repo then) and that of the US 6.5 per cent. And, the lowest was 125 bps in June 2006 when India’s policy rate was 6.5 per cent and US’s 5.25 per cent.

In the last decade, once (in January 2012) the spread between the US and India policy rate was as much as 850 bps — when India’s policy rate was 8.5 per cent and US Fed rate was zero.

With the latest hike, the spread between the US Fed rate and that of India has shrunk to 240-265 bps (US 3-3.25 per cent: India 5.4 per cent). The lower spread is a threat to currency as money flows to a plane where the return is higher.

The rupee closed at 80.99 a dollar last Friday after touching a new low of 81.26 even as the dollar index surged to a new two-decade high of 113.19.

The RBI has been intervening to curb volatility in the currency market. India’s foreign exchange reserves have shrunk by $96.80 billion in the past one year — from $642.45 billion on September 3, 2021 to $545.65 billion on September 16, 2022. Of course, the entire depletion is not on account of the RBI’s dollar sale to smoothen the rupee depreciation; the depreciation of other currencies vis-à-vis the dollar and the value of gold have also contributed to that.

A sliding rupee heightens concerns about India’s widening current account deficit. Foreign institutional investors had turned net buyers of Indian equities in July after dumping shares for eight months in a row. They have started selling shares again as a weak rupee eats into their returns.

Simply put, the RBI could hike the rate by 50 bps, not to fight inflation alone but also to stem the currency depreciation and, thereby, imported inflation. Even though exchange rate management is not the MPC’s mandate, it will certainly consider the depreciation of the currency while taking the call since it affects inflation.

A 50-bps hike will take the policy rate to 5.9 per cent. This is not the last hike in the current cycle. There will be more. It will cross 6 per cent and probably inch towards 6.25-6.5 per cent.

Will the RBI revise its growth estimate downwards? It could. The current growth estimate for FY23 is 7.2 per cent.