RBI retains hawkish stance; further pressure on equities

RBI retains hawkish stance; further pressure on equities

So, the Reserve Bank hiked the policy rate 25 basis points as expected. But what probably disappointed the markets, at least initially, was the retention of the hawkish stance. At the time of writing, equities have bounced back. But things are only going to get tougher.

It is “imperative to persist with the current anti-inflationary stance. Going forward, the stance will be influenced by signs of downward movement in the inflation trajectory," the policy statement read.

In other words, the RBI is not concerned about slowing growth. But has growth really slowed that much as the hue and cry suggests? Consumption demand is still going strong. Core inflation reflects that strong demand which in turn allows companies to retain pricing power and also push up wages. The latest purchasing manager’s indices show that output prices are still going up. Another indicator of robust demand lies in non-oil imports which are looking up as well. Even the Index of Industrial production (IIP) numbers show that demand for consumer goods and basic goods are going well.

As long as this demand continues, inflation is going to remain at higher levels and the central bank has no choice but to hike rates. Indeed, it wants growth to slow down. But there is a worrying corollary. Investment demand will slow down, leave aside the volatility in the capital goods index. Indeed, in its September bulletin the RBI itself notes that “Going by the assessment on date…in all likelihood, capital expenditures in 2011-12 are likely to be lower than the previous year."

Of course, it can be argued that RBI has no control over commodity prices (including food prices, which is why it castigated the government in the last review). But what they are probably trying to do is to prevent firms from passing on those costs, thus adding to the price-wages spiral. By the time of the next review in October, inflation is hardly likely to come down to 6-7% levels that RBI wants. So the chances of another round of interest rate hike remains strong.

What that also means is that companies are going to bear the brunt of further rate hikes and that may put further pressure on equity prices.