Expect another round of rate hike in May3 min read . Updated: 18 Mar 2011, 12:58 AM IST
Expect another round of rate hike in May
Expect another round of rate hike in May
There is no surprise in the Reserve Bank of India’s (RBI) decision to hike its policy rates by 25 basis points (bps) each, but the tone of the three-page mid-quarter policy statement is more hawkish than most analysts would have expected. RBI has made no bones about the fact that the stubbornly high inflation rate is a grave concern and the central bank will persist with its anti-inflationary stance. This means it’s almost certain that RBI will go for yet another round of rate hike in May when it announces the annual monetary policy for fiscal 2012, because inflation is unlikely to come down dramatically by then.
Indeed, for the second time this year, RBI has raised its March-end inflation projection to 8%, 2.5 percentage points higher than its original projection. Wholesale price-based inflation rose to 8.31% in February. The fact that inflation never dropped below 8% in the past one year makes it clear that RBI’s monetary policy, even though the most aggressive among Asian central banks, continues to be accommodative as the policy rate is persistently lower than the rate of inflation.
The most critical part of the February inflation figure is that while food inflation came down from 15.7% to 10.65%, the non-food manufacturing inflation rose sharply from 4.8% in January to 6.1%, making it abundantly clear that RBI’s apprehensions about high food inflation spilling over to other sectors and causing a spike in generalized inflation are not misplaced.
Expectedly then, the policy statement has touched upon the risks to growth. At one place it said, “The underlying inflationary pressures have accentuated, even as risks to growth are emerging," and at another place, RBI will “continue to rein in demand-side inflationary pressures while minimizing risks to growth". But the final guidance focuses more on fighting inflation at the current juncture than keeping the growth momentum—“based on the current and evolving growth and inflation scenario, the Reserve Bank is likely to persist with the current anti-inflationary stance".
RBI’s concerns on growth are in the medium term because it has not made any change in its 8.6% projection for economic growth in 2010-11. It has also said that even though the factory output numbers are volatile (industrial production grew at 3.7% in February year-on-year after a 2.5% growth in January), all other indicators such as corporate tax collection, exports, bank credit and the latest Purchasing Managers Index suggest no slowdown in the growth momentum in the world’s second fastest growing major economy. While growth can decelerate in the medium term and fall short of finance minister Pranab Mukherjee’s 9% projection for fiscal 2012, RBI’s immediate concern is inflation, which is now turning out to be demand-driven.
With the latest rate hike, the eighth since March 2010, the repo rate, or the rate at which RBI infuses liquidity into the system (or lends to banks), has gone up to 6.75%, and the reverse repo rate, or the rate at which the banking regulator sucks out liquidity (or borrows from banks), to 5.75%.
From the point of view of banks and companies, the latest rate hike is probably a non-event as bankers are unlikely to rush to raise their loan and deposit rates. They have done so at least twice in the past few months and this round of policy rate hike has already been factored in. So, companies and individual borrowers may not need to fear that their cost of borrowing will go up overnight.
Banks will probably not be in a hurry to raise their rates even in April as typically the demand for credit is slack in the first half of any fiscal year. In the absence of any loan demand, they would not need to raise their deposit rates too. But money will become more expensive once RBI decides to raise its policy rate again in May. And even that may not signal the end of the rate tightening cycle in India. There could be a few more round of rate hikes till the end of the year, until inflation comes down below the policy rate or growth prospects are seriously jeopardized by the tight money policy.