Mumbai: A Reserve Bank of India (RBI) survey, on the eve of the central bank’s third quarter monetary policy review, has raised the outlook for economic growth in the current fiscal. This, combined with RBI’s increasing worry on rising inflation, expressed in its third quarter review of macroeconomic and monetary developments released on Thursday, has strengthened the expectations of many analysts and economists on possible measures to tighten money supply.
RBI’s concern was buttressed by food price inflation rising to 17.4% for the week ended 16 January from 16.81% the week before, according to official statistics released on Thursday. India’s overall inflation rate, based on the Wholesale Price Index, rose sharply to 7.31% in December, from 4.78% in the previous month mainly on account of increasing food prices. According to RBI, India runs the risk of inflation “getting transmitted” to industrial goods and services as wages rise.
Based on the professional forecasters’ survey conducted in December, the outlook for 2009-10 growth has been revised upwards, from 6% to 6.9%.
With stronger recovery, the pressure on profit margins is expected to be relieved in the coming months, but with the return of pricing power, inflationary pressures would increase, RBI warned.
The pattern of capital flows, the pace of recovery in demand for credit from the private sector and the fiscal stance would influence monetary and liquidity conditions in the near term.
Tackling challenges: RBI governor D. Subbarao. Abhijit Bhatlekar/Mint
Still, analysts don’t expect RBI governor D. Subbarao to announce an increase in key interest rates on Friday, although they say he will take a clear stand on where the central bank is heading.
“By March-end, we could see the wholesale-priced based inflation inch up to 8.5%. RBI may look at tightening liquidity in the system. In that process, a hike in the cash reserve ratio (CRR) should not come as a surprise,” said Samiran Chakraborty, regional head of research (India) at Standard Chartered Bank. “The central bank would also prepare the system for a possible hike in interest rates in the coming quarter.”
RBI has kept CRR, or the proportion of deposits that banks need to keep with the RBI, at 5% since January 2009, the benchmark reverse repurchase rate at 3.25% and the repurchase rate at 4.75% since April. In the last monetary policy in October, RBI ordered lenders to keep a higher proportion of their deposits in government bonds by raising the statutory liquidity ratio to 25% from 24%.
The reverse repurchase rate is the rate at which RBI sucks out excess liquidity from the financial system; the repurchase rate is the rate at which it injects liquidity.
RBI will continue to focus on managing liquidity and tempering inflationary expectations, in line with the monetary policy stance outlined in the October policy, said Shubhada Rao, chief economist, Yes Bank Ltd. She expects the cash reserve ratio to be raised by 50 basis points on Friday. One basis point is equal to one-hundredth of a percentage point.
Even that may be too much to handle for an economy still emerging from a slump caused by the global meltdown.
“If a CRR hike of 50 basis points is imposed, it would drain the system of Rs20,000 crore of primary liquidity that could impose further strain on the system. It could be risky for RBI to allow the overnight rate to show sharp swings between the reverse repo and the repo rate under the current still uncertain conditions,” said Indranil Pan, chief economist, Kotak Mahindra Bank Ltd. “Our base case is for a ‘no change’ in CRR on Friday as we do not view the current liquidity as too ample. There remains a slender chance of a 25 basis points upward adjustment in the reverse repo rate.”
RBI said in its report that it expects recovery in private demand in the near demand.
“Better expectations about order books, capacity utilization and production revealed by the survey are indicative of both improved demand conditions as well as perceptions of further recovery in private demand in the near term,” RBI said. It also expects the working capital finance requirement to grow further during the last quarter of 2009-10, which suggests that demand for short-term funds from the private sector may rise in the coming months.
Industrial growth, which slowed significantly during the second half of 2008-09, has recovered in 2009-10, especially since June 2009. The Index of Industrial Production (IIP) posted double-digit growth in August, October and November 2009, suggesting an acceleration in the recovery process. During April-November, industrial growth was at 7.6%, significantly higher than 4.1% in the year-ago period.
Despite the growth in industrial activity, non-food credit growth at scheduled commercial banks decelerated over 12 months following the peak reached in October 2008. This has shown a reversal in trend since November 2009, increasing from 10.3% year-on-year as on 6 November 2009, to 14.4% as on 15 January 2010. RBI’s current indicative projection is 18% for 2009-10.
RBI said the decline in credit offtake could be partly explained by the availability of alternative non-banking sources of funding, including internal resources of companies, besides the impact of the economic slowdown on credit from the demand side.
The recovery shouldn’t make financial planners complacent, said an expert.
“The kind of industrial recovery we saw in the last few months really surprised everybody but if one sees the growth between April and December, it is not that high and is still nascent,” said Devendra Kumar Pant, director of research at Fitch Ratings India Pvt. Ltd. “It’s true that private demand is increasing as people who were cautious of the uncertainty are spending now.”
Subbarao will have to balance his concern over inflation with the need to nurture growth.
“I feel there will be some sort of monetary tightening and chances of CRR hike is pretty high. There should be an exit from all the stimulus packages but it will be gradual,” Pant said. “At the same time, inflation is increasing and monetary policy is not capable of controlling supply side driven inflation but it can check inflationary expectations. So it’s a Catch 22 situation for the RBI.”
Anup Roy contributed to this story.