Mumbai: A top Indian central banker signalled it would continue to tighten monetary policy but warned against overreacting amid global economic uncertainty, casting doubt on the chances of an interest rate rise before a 27 July policy meeting.
Reserve Bank of India (RBI) deputy governor Subir Gokarn told the Economic Times that rates were still too low given the fast pace of economic recovery and inflation, which touched double digits in March.
“The current level of policy instruments is not fully aligned with the state of the economy,” Gokarn told the newspaper in an interview published on Wednesday.
“The direction of policy is very clear and it is really a question of pacing. We have to be careful when we act, and there is a danger in overreaction. With the kind of uncertainty that we still see, we prefer to be more cautious.”
A slew of comments from RBI officials this week may be a move to address criticism that the bank is behind the curve in tackling stubbornly high inflation, while also facing pressure from the government to preserve strong growth rates.
However, caution stemming from Europe’s debt crisis, a concern voiced by several other Asian central banks such as Japan and Thailand, and tight liquidity in India should ensure the RBI takes a measured approach to tightening.
“The bank is indicating that while the current numbers are torrid and it will continue to tighten, the outlook over the next 12 months makes it unclear that greater aggression is necessary at this point of time,” said Atsi Sheth, chief economist at Macro-Sutra in Mumbai.
By 11:25 a.m., the 10-year benchmark bond yield was 5 basis points lower than its previous close, echoing the sentiment that the RBI was likely to keep rates steady until its 27 July quarterly review.
The 5-year swap rate was at 6.88% from its previous close of 6.90%, after rising to a near two-month high of 6.95% on Tuesday in what would normally signal expectations of more aggressive tightening..
But traders said that the swap curve or bond yields may not accurately reflect those expectations, as heavy cash outflows from banks have effectively increased banks’ cash reserve ratio (CRR), another tool used to tighten policy.
“I don’t think we will see inter-policy rate hikes,” said Pradeep Madhav, CEO of STCI Primary Dealer. “The fact is that Rs1 trillion of liquidity which has gone out ... itself amounts to a CRR hike of approximately 2.5%.
“The near-end interest rates have moved up. Inflation is high and yes it needs to be tackled but the system has already dried up of liquidity. I don’t think the money is going to return for at least a month,” he added.%.
A Reuters survey shows that most analysts do not see the RBI raising rates before the 27 July review, in line with the bank’s earlier stated preference for “baby steps” toward normalisation. However, it was still expected to raise rates at the meeting itself.
Clearing the Air
Gokarn’s comments follow remarks by another RBI deputy governor, K C Chakrabarty, who said on Tuesday that inflation is a bigger concern than the situation in Europe, and the finance minister, who toned down earlier remarks to back the bank over taming inflation.
When asked whether the Indian central bank could raise rates ahead of the July review, Chakrabarty had replied “absolutely”.
A senior official at a state-run bank, who declined to be identified, said Gokarn appeared to be trying to clear the air about the confusing remarks made earlier by policymakers.
“I think it is correct to interpret it as the RBI is watching the situation, which in itself can be interpreted as measured tightening.”
The RBI raised its key short-term lending and borrowing rates by 25 basis points each in March and April. The repo rate now stands at 5.25% and reverse repo is at 3.75%.
Concerns of an off-cycle rate hike ahead of the 27 July review rose after stronger-than-expected factory output growth and a sharp acceleration in May wholesale price inflation.
The newspaper also quoted Gokarn as saying the bank was well aware of the liquidity squeeze due to advance tax outflows and payments towards 3G auctions and wireless broadband spectrum and that the RBI would make sure that no undue pressure develops.