To prop-up the currency, as it teeters close to its all-time weakest level against the dollar, India’s Central Bank is widely expected to hike interest rates this week.
But analysts now fear the Reserve Bank of India could leave the currency to depreciate, choosing instead to keep rates unchanged as they focus on stabilising financial institutions.
Analysts suggest the Reserve Bank of India may choose to protect the nation’s financial system and markets after the near-collapse of Infrastructure Leasing and Financial Services (IL&FS).
The non-bank lender sparked a series of ratings downgrades after defaulting on a series of debt obligations.
A monetary policy decision is expected on Friday.
Analysts from Mizuho Bank said: ”RBI will probably stay put in the upcoming meeting, in contrary to consensus.
“RBI does not appear to be inclined to lift rates just to protect (the Indian rupee) unless there is clear evidence that a weaker currency has pushed up imported inflation.”
Investors were rattled by the IL&FS defaults and in turn sold bonds stocks over fears of potential market collapse.
Shadow banking companies accounted for more than 66 percent of funding provided to India’s commercial sector in 2017, a staggering 44 percent increase from the year before.
Analysts fear non-bank lenders will now struggle in the shadow of the IL&FS as investors steer clear from the sector.
India has the third-largest economy in Asia and is worth around $ 2 trillion, a figure which is expected to grow by 7.3 percent this year, according to a World Bank report.
Mitul Kotecha, senior emerging markets strategist at TD Securities, told CNBC that problems in the shadow banking sector “makes life a lot more difficult for RBI”.
He said: ”We know the banking sector issues in terms of recapitalization have been ongoing for a while, but this is non-bank financial sector… and I think that could have a bigger impact on liquidity.”
Shashank Mendiratta, an economist at ANZ, also predicted that the central bank will make no changes to interest rates and instead opt to repair damage done to the financial sector.
He said: ”We believe that financial stability is a more immediate concern.
“Although the combination of higher oil prices and a weak rupee have raised concerns about the inflation path, the recent soft inflation prints suggest that the RBI can afford to wait and see.
“Stabilising the rupee by raising interest rates does not appear high on the agenda.”
However, a Reuters poll of 64 experts found 29 of them are predicting India’s benchmark policy rate to remain at 6.5 percent.
The remaining 35 believe the outcome could be a hike of between 25 and 50 basis points.
ING economist Prakash Sakpal said: “We still can’t underestimate the potential inflationary impact of ongoing currency depreciation.”
A predicted rate hike would be the RBI’s third this year, after it lifted borrowing costs in June and August.