India’s central bank may raise rates to protect its currency

India’s central bank may defy expectations that it will leave interest rates unchanged during its monetary policy decision meeting on Friday.

Most economists polled by CNBC expect the Reserve Bank of India to keep rates unchanged at 5.25% while noting that a rate hike is only possible later this year.

Few expect policymakers to take part in this week’s meeting in an effort to bolster the rupee, which has fallen to a record low against the dollar.

CNBC conducted a survey of nine economists last week, ahead of the RBI’s policy decision.

But it “makes a lot of sense,” for India’s central bank to set a different course and raise interest rates, said Venugopal Garre, managing director and head of India research at Bernstein, speaking on CNBC’s Inside India on Tuesday.

The rate hike would bring India into line “with how global rates have been moving in recent weeks,” and could contain an exit at a time when “devaluation has been a major pain point for policymakers,” he added.

India’s peers are in the region – some beating expectations – to move further up the inflation curve.

Like India, Indonesia has been struggling with a falling currency, and on May 20, the country’s central bank raised its policy interest rate by 50 basis points more than expected. Sri Lanka’s central bank on May 26 raised its policy rate by 100 bps, the largest increase in four years.

India’s currency has been under pressure from its rising import bill and steady outflows, leading Prime Minister Narendra Modi to urge citizens to help save foreign currency.

Policymakers have also taken steps to protect the struggling rupee, including selling dollars through state-owned banks to stem its slide, according to a Reuters report. The government has also proposed to curb the demand for gold, a move aimed at saving foreign currency.

The rupee continues to be among the weakest currencies in Asia, although it has risen from record highs and is approaching the psychologically important 100 against the dollar.

Referring to exchange rate volatility, RBI Governor Sanjay Malhotra said the central bank will do “whatever is necessary to ensure orderly pricing in the forex market,” in an interview with news website Mint on May 25.

Although Malhotra did not specifically say that a rate hike was under consideration, his comments suggested that he was preparing the financial and bond markets for a bold move with all options on the table.

Another factor that could push the RBI to favor a rate cut is the risk of high inflation.

While India’s inflation rate remains below the RBI’s target of 4%, some economists believe that the combined inflationary pressures from higher energy costs, a weak currency, and weather-related crop shortages could force the RBI to take an early bailout step.

There are growing risks of future inflation due to “the passing on of higher energy costs to consumers” and “any weather-related disruption due to El Nino this year,” said Sakshi Gupta, Principal Economist at. HDFC Bank.

In April, despite the government keeping prices at the tap unchanged, India’s consumer price inflation rose for the sixth consecutive month to 3.48%.

But in the last two days, the government has increased fuel prices several times, which can lead to a big increase in inflation.

A combined fuel price increase of 7.5 rupees a liter ($0.08) beat Citi’s forecast of 5 rupees, leading the brokerage to raise its median inflation forecast for the fiscal year ending March 2027 to 4.9% from 4.6% previously.

“We still expect the June MPC to keep rates on hold,” the brokerage said in a report on Saturday, referring to the central bank’s Monetary Policy Committee, but adding that it expects two 25-point rate hikes in August and October.

Bad El Niño forecasts could force the RBI to raise inflation and raise interest rates sooner rather than later. El Niño refers to the warming of ocean water temperatures, which occurs naturally every few years. In its April meeting, the Reserve Bank of India warned that El Niño could pose a threat to inflation.

Those predictions now look grim.

“El Niño will arrive on our doorstep in the coming months with a 90% certainty,” António Guterres, the secretary-general of the United Nations, said in a statement on Tuesday. He added that the world needs to take this as an “urgent climate warning,” and warned that “the impacts will be severe.”

Meteorologists have lowered expectations for India’s monsoon season this year, predicting rain at 90% of the long-term average, according to several local media reports.

That’s weaker than the 92% estimate issued in April and would mark the worst hurricane activity in 11 years. India is already experiencing extreme heat, and about 60% of its agriculture is dependent on rain.

Food inflation, a key component of India’s consumer price index, rose 4.2% in April from 3.87% in March.

Adding to its food production problems, UN Food and Agriculture Organization Chief Economist Maximo Torero said India is facing a shortage of fertilizers ahead of India’s crucial Kharif sowing season.

“If the crisis (Gulf conflicts and below normal rainfall) continues, India faces higher import costs, reduced availability of domestic fertilizers, and inflationary pressure on food, especially wheat, rice and vegetables,” he said in a report published on the website of news agency ANI on April 22.