Mumbai: The Reserve Bank of India (RBI) on Monday said it is necessary to lower inflation “as quickly and as decisively as possible” to sustain the growth momentum in the world’s second fastest growing major economy, indicating in no uncertain terms that it would continue to raise rates to fight inflation.
Since March 2010, RBI has hiked its policy rate by 350 basis points (bps) to 6.75% in eight tranches.
For the fiscal year ended 31 March, wholesale price inflation rose to close to 9%, beating RBI’s estimate—raised twice during the year—by almost a full percentage point.
The Indian central bank’s report Macroeconomic and Monetary Developments in 2010-11, released ahead of its annual monetary policy, said inflation in 2012 would moderate slowly, but remain above its “comfort level”.
“Risk to growth from sustained high inflation could condition the stance of the monetary policy in near term,” the report said, adding, “since high inflation itself could disrupt growth, it is important for the monetary policy to ensure a low inflation environment as a pre-condition for sustained high growth.”
This prompted many analysts and economists to believe that RBI may go for a higher dose of policy rate hike even though they do not dub the central bank’s stance excessively hawkish and say it is “balanced”.
“The tone is hawkish on inflation, but it is well placed for both inflation and growth concerns,” said A. Prasanna, economist at ICICI Securities Primary Dealership Ltd.
Based purely on recent data points, most economists see rates going up by 50 bps on Tuesday. One basis point is one-hundredth of a percentage point.
Fearing a sharp rate hike, investors sold bank stocks on Monday, leading to a sharp fall in most stocks. All 14 stocks that constitute the Bombay Stock Exchange’s (BSE) banking index, Bankex, fell.
Shares of Bank of India fell the most, losing 7.73% of their value to close at Rs 421.65 each.
Among other bank stocks, shares of Canara Bank fell 5.72%, Vijaya Bank, 5.6%, United Bank of India, 4.82% and State Bank of India, the nation’s largest lender, 4.06%.
Among private banks, shares of ICICI Bank Ltd fell 1.44% and HDFC Bank Ltd, 0.08%.
The Sensex, the benchmark index of BSE, fell 0.72% to close at 18,998.02 points.
The Bankex was the worst performer among the sectoral indices, losing 2.08% to close at 12,804.48 points.
Apart from the apprehensions about a 50 bps hike in policy rate, bank stocks also reacted to news reports on a possible 50 bps hike on savings rate. If that happens, banks’ cost of deposits will go up sharply and their net interest margin, or the difference between cost of deposits and yields on advances, will shrink.
About 22% of banking industry’s deposits are savings accounts on which they pay 3.5% interest. RBI could raise the rate to 4% to protect the interest of savers against persistently high inflation.
Apurva Shah, vice-president and head (research strategy, financial services) at Prabhudas Lilladher Pvt. Ltd, said the stocks were depressed because an increase in rates would likely squeeze interest margins for banks.
In the past, RBI had assumed growth was robust and investment demand, buoyant. This time though, it flagged off concerns about the potential impact of inflation on growth and said investment demand too is slowing down.
“High energy and commodity prices may impact output and investment climate, and pose a threat to maintaining high growth at a time when the investment momentum may be slowing down,” RBI said, adding, “fresh pressures from commodity prices do make 2011-12 a challenging year for inflation management.”
It also made it abundantly clear that high inflation and high growth cannot coexist, as has been suggested by some economists, including Kaushik Basu, the government’s chief economic adviser.
“Balancing growth and inflation may be important in the short run, but in the long-run, persistent inflation is a significant threat to growth,” it said.
RBI also harped on the importance of containing the fiscal deficit and suggested that the government must try and bring down the subsidies on various petroleum products and fertilizers.
Despite risks to growth emanating from high oil prices and some moderation in investment, “GDP growth during 2011-12 is expected to stay close to the trend,” RBI said, even as various agencies, including the central bank’s survey of professional forecasters, are projecting a growth of 8-8.5%, lower than the government expectation of 9% growth.
The money market was subdued on Monday with the yield on 10-year bonds rising to 8.15% from 8.13% on Friday.
One-year overnight indexed swaps, a trading indicator of how short-term rates will move, ended at 7.88%, up just 1 bps after touching 7.9% from 7.87% on Friday.
J. Moses Harding, executive vice-president and head (global markets group) at IndusInd Bank Ltd, said the market is in a wait-and-watch mode, expecting a 50 bps hike in policy rates. “The market will be pleasantly surprised if there is only a 25 bps hike because it is anyway geared for the repo rate increasing to 7.5% in September from 6.75% now,” he said.
Ashwin Ramarathinam contributed to this story.