Conflict to weigh on Indian growth than inflation, keeping rates low

The US and Israel's attack on Iran is expected to weigh more on India’s economic growth than its inflation, which will encourage the Reserve Bank of India to keep interest rates low, three sources familiar with policymakers’ thinking and analysts said.

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The conflict, which has rippled out across much of the Middle East, has pushed up oil prices by about 15%, disrupted gas flows from the region and triggered selloffs in Indian equity, debt and currency markets, with the rupee hitting a record low and bond yields rising due to concerns about India’s current account deficit and the risk of higher inflation.

Despite a weaker rupee and higher crude prices, the central bank is unlikely to take a hawkish turn, all three sources familiar with policy deliberations said.

Current assessments could change, one of the sources cautioned, in case of extreme developments in the Middle East.

The thinking of policymakers appears to have diverged from the market reaction.

Interest rates have risen in emerging and global markets since the Gulf conflict broke out. Traders in India’s swap markets have added to bets on at least one rate increase over the next 12 months.

"I don't feel the market has sufficiently priced the risk from oil prices rising significantly and there could be room for swap rates to move even higher if Brent oil holds above $80 per barrel over the next couple of weeks," said Ritesh Bhusari, joint general manager for treasury at South Indian Bank.