Mumbai: On the sidelines of a 23 June event in Pune, Reserve Bank of India governor Yaga Venugopal Reddy conceded that “there is a legitimate concern about the recent developments on the inflation front”.
He then called upon all market participants, in particular the financial market participants, “to appreciate the problem with the analysis at their command, participate with us in managing demand and maintaining orderly conditions in financial markets, while drawing upon the strengths of their respective balance sheets.”
(REDDY RECKONER) This is possibly the strongest statement Reddy has ever made since his tenure began in September 2003.
On the same day, Reddy went on to say: “The RBI will continue to take determined and calibrated measures, as and when warranted, with a focus on managing expectations and on enabling adjustments in the economy in response to the oil shock.”
Indeed, the very next day, RBI announced a hike in the short-term policy rate, or so-called repo rate, by half a percentage point to 8.5%. The banking regulator also raised banks’ cash reserve ratio, or CRR, the cash that they are required to keep with the central bank, by an identical margin to 8.75%.
RBI also promised to resort to “both conventional and unconventional measures” to manage “inflation expectations, financial stability and growth momentum.”
(MINT SNAP POLL ON MONETARY POLICY) All this then brings us to what might have changed in this scenario during the past four weeks.
For one, India’s wholesale price-based inflation reached 11.05%, up from 4.28% a year ago. Since then, inflation has gone up to 11.89%. Still, the price of crude, the main trigger for the rising inflation, has dropped from $147(Rs6,200 today) a barrel to $124 a barrel.
But, apart from a drop in oil prices, there has not been any change in all macro-economic developments in the past one month. The banking industry’s credit as well as deposit growth have been higher than what RBI had projected in its annual monetary policy announced in April. So has been the growth in money supply and reserve money.
And many economists say, despite a fall in crude oil prices, high inflation is here to stay for a while. “Inflationary concerns will continue in India for another six months,” predicts Rupa Rege Nitsure, chief economist of the public sector Bank of Baroda.
According to Nitsure, just as the rise in crude prices was not fully passed on to the customers, the fall in crude prices also will not be felt by the masses.
“Under-recovery of oil marketing companies are almost 2.5% of GDP (gross domestic products). Only 25-30% of the increase in the crude oil prices has been passed on to the masses,” Nitsure said.
According to her, the bad monsoon this year, the worst for the last five years, has also spelt bad news as far as the sowing of kharif crops is concerned. The monsoon in July year was 2% below its long period average.
“All major commodities are under strain. Post monsoon there is always an increase in cement prices. And, steel price control will also ease from October. The governor has been saying that inflation will remain in double digits. Socially, it is an unacceptable level,” she added.
A recent Kotak Mahindra Bank Ltd research report also said the oil prices and monsoon will determine the inflation views. Kotak Mahindra Bank estimates that inflation could touch 14% by end December before it starts falling.
“International crude oil prices and the south-west monsoon (June-September) are two of the most important factors for inflation at the moment,” it said.
“We believe that RBI will act aggressively in the coming months to reign in inflationary expectations, even as inflation appears to have stabilized for the moment. We expect RBI to hike the repo rate by 25 basis points on 29 July credit policy and possibly another 50 basis points before March 09,” Kotak Mahindra Bank economists Indranil Pan and Kaushik Das said in their research report, dated 25 July.
Both Nitsure and Kotak Mahindra Bank’s economists say that CRR will be the preferred tool when liquidity improves, and could be exercised during inter-meeting dates.
A recent Lehman Brothers report, by its India economist Sonal Verma, also said the inflation rate is “unlikely to reach the RBI’s 5.5% target anytime during fiscal 2009” and “it will be interesting to see whether RBI officially changes its inflation target or just highlights the serious risk of its target being overshot.”
Lehman Brothers is expecting a 25 basis points hike in repo rate and a “50:50 chance” a 25-50 basis points hike in CRR.
ICICI Bank Ltd’s research division also expects a repo rate hike but no change in CRR. However, it does not rule out any post-policy measures if the “inflation scenario were to worsen significantly”.
Indeed, the industrial production growth has come down but analysts are not giving too much importance to that at this point.
“Our analysis suggests that the central bank pays little attention to industrial developments when determining rates,” HSBC economist Robert Prior-Wandesforde said in a research report. “While acknowledging the RBI often likes to surprise markets, we are sticking with our call of 25 basis points repo and CRR hikes at next Tuesday’s meeting and a total of 100 basis points of increases in both rates between now and the end of calendar 2008.”
Abheek Barua, chief economist of HDFC Bank Ltd, said the industrial production rate has fallen due to some adverse base affect of the year. “Inflation is going to be a priority now for the central bank rather than the growth. Hence, RBI would want to rein in inflation by hiking CRR. Any explicit rate signal will be given after this policy,” Baruah said.
HDFC Bank expects RBI to go for another 50 basis points hike in repo and 25-50 basis points hike in CRR, after the July policy. Indian overnight indexed swaps rose on Friday, as double-digit inflation kept alive expectations of more monetary tightening in the central bank’s policy review on Tuesday.