Has the Indian central bank reached the end of its rate tightening cycle with the latest round of 25 basis points (bps) rate hike on Friday?
One bps is one-hundredth of a percentage point.
The mid-quarter policy statement doesn’t indicate so. Many believe there could be at least another rate hike before it presses the pause button as inflation will remain high at least till November. Some analysts also feel the Reserve Bank of India (RBI) should have been more aggressive in the past. According to them, inflation expectations remain high because RBI chose to stay behind the curve till recently.
It may not be a bad idea to take a close look at the RBI language, verbatim, and action—or the lack of it—since March 2010, when it started raising rates. The tightening cycle, in fact, started even before that, in January 2010, when RBI raised banks’ cash reserve ratio, or the portion of deposits that commercial banks need to keep with RBI.
Edited excerpts from policy statements (emphasis mine):
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Background: …While the recovery in growth has proceeded broadly along expected lines, the inflationary pressures have intensified beyond our baseline projection. Even as food prices are showing signs of moderation, they remain elevated. More importantly, the rate of increase in the prices of non-food manufactured goods has accelerated quite sharply.
Action: Repo rate raised by 25 bps from 4.75% to 5%; reverse repo raised from 3.25% to 3.5%.
Expected outcome: These measures should anchor inflationary expectations and contain inflation going forward.
Inflation in March 2010: 10.36%; non-food, non-oil core inflation: 3.5%
(Inflation figures are always announced with one month lag effect. This means, while announcing the policy in any month, RBI is not aware of the inflation figure of that month.)
•Analysis: The beginning of rate tightening cycle as economy recovered from the impact of 2008 global meltdown and inflation started rising
Action:Repo rate raised by 25 bps to 5.25%; reverse repo rate raised to 3.75%.
Expected outcome:Inflation will be contained and inflationary expectations will be anchored and the recovery process will be sustained.
Inflation in April 2010: 10.88%, core inflation: 5.9%
2 July 2010
Action: Repo rate raised by 25 bps to 5.50%; reverse repo rate raised to 4% as part of the calibrated exit from the expansionary monetary policy.
Expected outcome: The … monetary measures should contain inflation and anchor inflationary expectations going forward, while not hurting the recovery process. … The monetary policy stance remains focused on containing inflation and anchoring inflationary expectations without hurting growth.
27 July 2010
Action: Repo rate raised by 25 bps to 5.75%; reverse repo rate raised by 50 bps to 4.50%.
Expected outcome: Monetary policy actions expected to moderate inflation by reining in demand pressures and inflationary expectations; maintain financial conditions to sustaining growth.
Inflation in July 2010: 9.98%, core inflation: 5.50%
Background: … The growth remains steady though the recent volatility in industrial production raises some concerns. Inflation also appears to have stopped accelerating though the rate may remain high for some months. The early signs of a downturn in non-food manufacturing inflation suggest that recent monetary actions are having an impact on both inflationary expectations and demand in a non-disruptive way.
Action: Repo rate raised by 25 bps to 6%; reverse repo rate raised by 50 bps to 5%.
Expected outcome: The measures should contain inflation and anchor inflationary expectations without disrupting growth; continue the process of normalization of the monetary policy instruments.
The Reserve Bank believes that the tightening that has been carried out over this period has taken the monetary situation close to normal. Consequently, the role of normalization as a motivation for further actions is likely to be less important.
Inflation in September 2010: 8.98%, core inflation: 5.30%.
• RBI misread the situation, said monetary situation was getting close to normal.
Action: Repo rate raised by 25 bps to 6.25%; reverse repo rate raised by 25 bps to 5.25%.
Expected outcome: These actions are expected to sustain the anti-inflationary thrust of recent monetary actions;…rein in rising inflationary expectations which may be aggravated by the structural nature of food price increases.
Based purely on current growth and inflation trends, the Reserve Bank believes that the likelihood of further rate actions in the immediate future is relatively low.
Inflation in November 2010: 8.20%, core inflation: 5.84%
•RBI misread the inflation scenario and made the mistake of committing inaction.
Action: No change in repo and revere repo rate.
Expected outcome: The underlying growth momentum of the Indian economy remains strong. Even as inflation has moderated, it remains significantly above the comfort level…. Risks to inflation remain on the upside, both from domestic demand and higher global commodity prices. There is, therefore, a need for continued vigilance on the inflation front against the build-up of demand side pressures.
Inflation in December 2010: 9.45%, core inflation: 6.21%
•RBI had to stay away from rate hike as committed—an avoidable inaction. Once again misread inflation trajectory.
Action: Repo rate raised by 25 bps to 6.5%; reverse repo rate raised by an identical margin to 5.5%.
Expected outcome: The actions are expected to contain the spillover from a rise in food and fuel prices to generalized inflation; rein in rising inflationary expectations.
Guidance: Looking beyond 2010-11, the Reserve Bank expects domestic growth momentum to stabilize… Inflation is likely to resume its moderating trend in the first quarter of 2011-12, but several upside risks are already visible in the global environment, and more may surface domestically.
For the fiscal consolidation process to be credible and effective, it is important that apart from augmenting revenue, the composition and quality of expenditure improves. Any slippage in the fiscal consolidation process at this stage may render the process of inflation management even harder.
Inflation in January 2011: 9.47%, core inflation 6.53%
•The first time the policy statement spoke about fiscal responsibility to contain inflation; it also recognized the fact that food inflation is spilling over to other segments.
Background: The underlying inflationary pressures have accentuated, even as risks to growth are emerging… As domestic fuel prices are yet to adjust fully to global prices, risks to inflation remain clearly on the upside, reinforced by the persistence of demand-side pressures as reflected in non-food manufacturing inflation.
Action: Repo rate raised by 25 bps to 6.75%; reverse repo raised to 5.75%.
Expected outcome: The policy action is expected to continue to rein in demand side inflationary pressures while minimizing risks to growth; contain the spillover of food and commodity prices into more generalized inflation.
Guidance: Based on the current and evolving growth and inflation scenario, the Reserve Bank is likely to persist with the current anti-inflationary stance.
Inflation in March 2011: 9.68%, core inflation 8.48%
•RBI saw demand pressure fuelling inflation and committed to continue with its anti-inflationary stance.
Action: Repo rate raised by 50 bps to 7.25%; reverse repo rate raised to 6.25%.
Expected outcome: The monetary policy actions are expected to contain inflation by reining in demand side pressures and anchor inflationary expectations; and sustain the growth in the medium-term by containing inflation.
Guidance: The inflation rate will remain close to the March 2011 level over the first half of 2011-12, before declining. The Reserve Bank will continue to persevere with its anti-inflationary stance.
Inflation in May 2011: 9.56%, core inflation: 7.26%
•First 50 bps hike since the rate tightening cycle started.
Background: …Recent global macroeconomic developments pose some risks to domestic growth. Domestic inflation remains high and much above the comfort zone … Particularly, non-food manufactured products inflation rose in May 2011 after showing some moderation in April 2011. … The impact of the Reserve Bank’s recent monetary policy actions is still unfolding. … While the Reserve Bank needs to continue with its anti-inflationary stance, the extent of policy action needs to balance the adverse movements in inflation with recent global developments and their likely impact on the domestic growth trajectory.
Action: Repo rate raised by 25 bps to 7.5%; reverse repo rate to 6.5%
Expected outcome: The policy action is expected to contain inflation and anchor inflationary expectations by reining in demand side pressures, and mitigate the risk to growth from potentially adverse global developments.
Guidance: The Reserve Bank will need to persist with its anti-inflationary stance.
Inflation in June 2011: 9.44%, core inflation: 7.31%
•The first time the policy document spoke about risks emanating from global developments.
Action: Repo rate raised by 50 bps to 8%; reverse repo rate 7%
Expected outcome: It is expected that these policy actions will reinforce the cumulative impact of past actions on demand; maintain the credibility of the commitment of monetary policy to controlling inflation… and reinforce the point that in the absence of complementary policy responses on both demand and supply sides, stronger monetary policy actions are required.
Guidance: The stance will depend on the evolving inflation trajectory, which, in turn, will be determined by trends in domestic growth and global commodity prices. A change in stance will be motivated by signs of a sustainable downturn in inflation.
Inflation in July 2011: 9.22%, core inflation: 7.53%
•The statement spoke about maintaining credibility and commitment of the monetary policy to control inflation. This explains why RBI went for yet another 50 bps hike. It also made no bone about the fact that it was a lone battle and the government was doing nothing to contain inflation.
Background: Developments in the global economy over the past few weeks are a matter of serious concern…Although India’s exports have performed extremely well in the recent period, this trend is unlikely to be sustained in the face of weakening global demand.
…Inflation remains high, generalized and much above the comfort zone. After a slight moderation in July, non-food manufactured products inflation rose again in August, suggesting continuing demand pressures.
Action: Repo rate raised by 25 bps to 8.25%; reverse repo rate 7.25%
Expected outcome: The rate hikes are expected to reinforce the impact of past policy actions to contain inflation and anchor inflationary expectations.
Guidance: The monetary tightening effected so far by the Reserve Bank has helped in containing inflation and anchoring inflationary expectations, though both remain at levels beyond the ... comfort zone. ..A premature change in the policy stance could harden inflationary expectations, thereby diluting the impact of past policy actions. ... Going forward, the stance will be influenced by signs of downward movement in the inflation trajectory, to which the moderation in demand is expected to contribute, and the implications of global developments.
Inflation in August 2011: 9.78%, core inflation: 7.8%.
• If inflation is not contained, it will be very difficult for RBI to press the pause button, unless there is a dramatic collapse on the growth front, driven by global developments.
Tamal Bandyopadhyay keeps a close eye on all things banking from his perch as Mint’s deputy managing editor in Mumbai. Your comments are welcome at firstname.lastname@example.org