Mumbai: A day before it unveils its annual monetary policy, the Reserve Bank of India (RBI) made it clear in a report on Monday that the thrust of the policy will be on dousing inflationary pressures in an expanding economy.
Although the report said “recovery in private demand needs to be stronger to reinforce the growth momentum” and “anchoring inflationary expectations without hurting the growth process” will be the focus, economists expect RBI on Tuesday to raise key policy rates as well as the cash reserve ratio (CRR), or the portion of deposits banks need to keep with it.
There is no consensus on the size of the likely hike in rates and CRR, though.
Fearing a rate hike, investors rushed to sell stocks on Monday, pulling down the bellwether index of the Bombay Stock Exchange, Sensex, by 190.5 points, or 1.08%, to 17,400.68, a one-month low.
The 50-share Nifty index of the National Stock Exchange declined by 1.12% to 5,203.65. Stocks in interest rate sensitive realty, automotive and bank sectors fell.
Wholesale-price based inflation touched a 17-month high of 9.9% in March.
The RBI report, titled Macroeconomic and Monetary Developments in 2009-10, expects the pace of inflation to be moderated in the next few months “but concerns relating to elevated levels of inflation remain the near term”.
And RBI is clearly worried on this front. Even though it is not fully convinced about the momentum of growth, combating inflationary pressures is its priority “since high inflation itself will dampen recovery in growth.’’
RBI’s survey of professional forecasters predicts 8.2% growth in gross domestic product for fiscal 2011, higher than the 7.2% estimate for 2010 and 6.7% in 2009.
“The growth momentum continues, but inflation doesn’t cease to be a worry, amplifying fears of a tougher stance by the RBI,” said Deepali Bhargava, chief economist at ING Vysya Bank Ltd. “We expect the RBI to hike repo, reverse repo and CRR by 25 basis points each in the forthcoming policy.’’
The repo rate is the rate at which RBI lends money to banks; the reverse repo is the rate at which it borrows from banks.
A basis point is a hundredth of a percentage point.
Vikram Kotak, chief investment officer, Birla Sun Life Insurance Co. Ltd, said RBI had so far stayed behind the curve in rate normalization due to concerns over economic growth, but with a robust pick-up in demand, recovery in private capital expenditure, signs of improvement in credit growth and high inflation, he expects “accelerated rate hikes.”
Despite rate hike expectations, many analysts say India’s growth will not be impacted.
“As long as there is demand in the economy and liquidity remain reasonably comfortable, a rate hike will not have a significant impact on growth,” said Devendra Pant, director of research at Fitch Ratings Ltd said: ...We have to remember that this is not monetary contraction or tightening of monetary conditions, but a withdrawal of easy money stance. So, it is not detrimental to growth.”
RBI has listed a few risks to growth such as monsoon-related uncertainty, a recent decline in the domestic saving rate led by a significant decline in public sector savings, and exit from fiscal stimulus and growth-supportive monetary policy.
Besides, private consumption demand needs to improve significantly to support the growth momentum, it said.
Apart from rising inflation, other concerns of RBI are a capital flows, a rising local currency and asset prices.
A relatively stronger economic recovery in India and “the favourable interest rate differentials in the face of easy global liquidity conditions could lead to higher capital inflows” and this in turn will influence both the exchange rates as well as asset prices.
“The strong rebound in asset prices needs to be monitored closely, given their implications to financial and macroeconomic stability,” the RBI report said.
Asset prices have increased at a relatively faster pace in the recent months, reflecting optimism about the economy’s prospects as well as easy liquidity conditions.
Both RBI as well as the government have started taking monetary and fiscal exit measures to tame rising inflation and growth in asset prices but the central bank has warned that an ill-planned exit from monetary and fiscal stimulus would mar growth.
“The exit from fiscal stimulus and the growth supportive monetary policy, unless calibrated carefully, could impact the growth process,” the report said.
To some analysts, the emphasis on combating inflationary pressure without hurting growth is seen to suggest that RBI is unlikely to be aggressive in increasing rates in its annual policy although its tone will be decidedly hawkish.
This may or may not come true as rarely does the Indian central bank reveals all its cards ahead of the policy announcement.