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Business News/ Money / Personal-finance/  A 25 bps rate hike will not affect growth
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A 25 bps rate hike will not affect growth

A 25 bps rate hike will not affect growth

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On the eve of the Reserve Bank of India’s (RBI) second quarter monetary policy review, the equity market was completely unfazed, with the benchmark Sensex index of the Bombay Stock Exchange (BSE) rising 1.6%.

Also See Optimism Prevails (PDF)

As if to drive home the point that a 25 basis points (bps) rise in the policy rate is of little consequence for the markets, the rally was led by banking stocks. One basis point is one-hundredth of a percentage point. The BSE Bankex rose by 3.4%, while the other interest-rate sensitive index, the BSE Realty index, moved up by 2.9%.

At the time of its mid-quarter monetary policy review in mid-September, RBI had said its policy of normalizing interest rates had been achieved and further policy action would depend on data. On the eve of the central bank’s second quarter policy review, what is the data telling RBI?

RBI’s review of monetary and macroeconomic developments for the second quarter is quite clear that anchoring inflation expectations remains the priority. It says several times that inflation remains above the comfort level.

A slew of data on Monday underlined the fact that growth is strong and more needs to be done to contain inflationary expectations. The HSBC Manufacturing Purchasing Managers’ Index (PMI) bounced back in October. The dip in the month-on-month seasonally adjusted indicator in September has been corrected and the index is back around the levels it has been at since June.

The China Manufacturing PMI also increased in October to 54.8 from 52.9 in September, indicating that growth in China is picking up once again. A reading above 50 indicates expansion. That means global commodity prices could be strong. The Thomson Reuters/Jeffries CRB index has moved up sharply in October.

RBI will have to also take into account the impact of higher raw material prices; the input prices sub-index in the India manufacturing PMI has been rising.

Indian companies are brimming with confidence. The NCAER-MasterCard index of business confidence is at an all-time high, well above the levels reached in the July survey. The results of RBI’s survey of professional forecasters in September show a marginal upward revision in the gross domestic product growth rate from 8.4% to 8.5%.

RBI’s Industrial Outlook Survey shows a rise in optimism about the strength of demand for the October-December period. The business confidence survey for the second quarter of 2010-11 by industry lobby Federation of Indian Chambers of Commerce and Industry (Ficci) shows high and rising levels of optimism. Corporate-level monthly data shows demand continues to be very strong in automobiles and cement.

To be sure, signs of moderation are seen in non-oil imports, which were lower in September than in August. Banks have raised rates for deposits and advances. Real deposit rates are no longer negative, if we take expected inflation at around 6%. And liquidity conditions are tight at the moment.

Will a higher interest rate differential mean more fund flows to India? The bulk of inflows to India are into the equity market, which depends more on corporate earnings than on the level of interest rates.

RBI can also take comfort that its tightening initiatives will not dampen investment. As the recent Ficci survey says: “Companies have reported that successive doses of monetary policy tightening by the central bank have now started affecting the lending rate structure, with 86% of the firms of the view that lending rates would further go up in the coming months. Yet, this upward revision of lending rates would not lead to deferment of investment plans, with 75% of the firms saying that investments would go ahead as planned."

With growth taken care of, RBI will do well to concentrate on anchoring inflation expectations.

We welcome your comments at marktomarket@livemint.com

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Published: 01 Nov 2010, 11:53 PM IST
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