Mumbai: The Reserve Bank of India (RBI) is likely to resume its rate tightening cycle in January and raise key interest rates by another 75 basis points (bps) in 2011, Deutsche Bank said in a note this week.
The Reserve Bank of India has raised rates by 150 basis points in six moves since mid-March, with its latest move earlier this month, to try to tame stubbornly high inflation but said there was little chance of another increase in the near term.
Taimur Baig and Kaushik Das, economists at Deutsche Bank, wrote in the note that even if inflation heads below the RBI’s target of 6% by March, the risks to inflation are likely to be tilted towards the upside.
They said inflation rate may not rest at 5% or so after March given the supply/demand dynamic, and head higher again. “The central bank would like to push inflation below 5% in the medium term,” they said.
The central bank officials also look ready to tackle inflation volatility forcefully, given its distortionary impact on the economy, even if measures to stem volatility come at the cost of a somewhat lower growth rate, they added.
Highly anemic deposit growth rate has brought forth the undesirability of negative real interest rates, raising the central bank’s motivation to normalize rates.
Deutsche Bank expects inflation to stabilize around 6% levels next year, and for real interest rates to be comfortably positive, the repo rate needs to be at 7%, they said.
At present, repo rate, or the central bank’s key lending rate, stands at 6.25%, while reverse repo rate, or its key borrowing rate, stands at 5.25%.
Asset price concerns
The central bank at its 2 November policy review also voiced concern over the sharp rise in asset prices, including stocks, property and gold, and tightened provisioning rules for home loans.
“We expect more such measures in 2011, especially if loans to finance housing and equity market activities continue to rise. The RBI does not seem particularly concerned about higher interest rates or tighter lending restrictions to impact the real economy,” Baig and Das wrote.
Deutsche Bank also said the Indian economy was in a better position to absorb capital inflows without having any destabilizing impact on the financial system.
The bank expects broad direction of the rupee to be one of appreciation, though intermittent reversals cannot be ruled out in case of risk aversion-led equity market corrections.
“With access to the debt market tightly controlled, the RBI is not particularly worried about an asset market sell-off creating difficulties for the government, in our view,” the economists said.
“If flows were to surge further, some prudential measures could be taken or financial institutions could be forced to ramp up risk management. Outright measures to contain capital inflows are unlikely, in our view.”