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Contradictory signals from RBI

Contradictory signals from RBI
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First Published: Tue, Nov 02 2010. 10 28 PM IST
Updated: Tue, Nov 02 2010. 10 28 PM IST
While the 25 basis points hike in the repo and reverse repo rates caused barely a ripple, the Reserve Bank of India’s (RBI) uncharacteristically explicit statement that “based purely on current growth and inflation trends, the likelihood of further rate actions in the immediate future is relatively low” was quite a surprise. One basis point is one-hundredth of a percentage point.
Also See | Chasing inflation (Graphic)
True, the central bank has made no change to its inflation forecast for March 2011. But it does a lot of hand-wringing over inflation, pointing out, for instance, that “when the economy is growing close to trend, the risks of structural food inflation spilling over into prices of other commodities are significant and that could potentially offset the recent moderation”.
RBI also agonizes over rising global commodity prices and demand pressures from tightening capacity constraints. While talking about risk factors, the statement says unequivocally that “going forward, the risks to inflation are largely on the upside”.
Its decision to keep rate hike in abeyance in the near future appears to directly contradict these concerns. What prompted RBI to stick its neck out in a manner so atypical of central banks is somewhat of a mystery.
We would add two more reasons to RBI’s list. Input prices are rising and, while companies have so far been absorbing part of the price increases, it’s a matter of time before capacity limits are reached and output prices, too, are hiked. And, most importantly, the US Federal Reserve’s decision on quantitative easing looms over the Indian markets, threatening continued inflationary pressures.
For all these reasons, any pause may be temporary and RBI’s statement should not be construed to mean the rate cycle is turning.
The bond markets, though, took comfort from the announced pause in tightening and from the announcement of buy-back of securities to infuse liquidity, with the 10-year yield falling to 7.97% at the end of the day compared with 8.11% on Monday.
Sujoy Das, head of fixed income at Religare Mutual Fund, said, “The RBI governor’s comments on a pause in rate hikes temporarily improved sentiment in the bond market, which will continue to look for cues from the liquidity situation and from the inflation numbers.”
Another interesting point made in the policy announcement is RBI’s concern with rising asset prices. It mentions the rise in equity, property and gold prices, and says that “a sharp rise in asset prices in such a short time causes concern”.
It has attempted to deal with one aspect of the asset price rise, by pre-emptively trying to cool housing prices. There’s a debate about whether central banks should act to cool asset prices and RBI action suggests it will certainly try. The asset price rise also needs to be seen in the backdrop of further quantitative easing in the US and the funds finding their way to asset markets.
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First Published: Tue, Nov 02 2010. 10 28 PM IST