Home / Politics / Policy /  RBI may hike interest rates in January if high inflation persists

Mumbai: Reserve Bank of India (RBI) governor Raghuram Rajan left a key lending rate unchanged in the expectation that prices will ease in the coming months, and to boost slowing economic growth, but warned that the central bank would raise the rate if inflation doesn’t slow.

RBI kept the repo rate, at which it lends short-term funds to banks, at 7.75%. The rate has been raised twice so far, since Rajan, a former chief economist with the International Monetary Fund, took over as the RBI governor on 4 September.

The central bank also kept the cash reserve ratio, which defines the portion of deposits banks need to park with RBI, unchanged at 4%, and the rate of emergency borrowing for banks, through the so-called marginal standing facility, at 8.75%.

The rate pause came as a pleasant surprise to the financial markets. The rupee and stocks rose and bond yields fell sharply as investors rushed to buy local assets, hoping for the comfort from a benign interest rate environment, which will, in turn, act as a catalyst to the business growth of companies by lowering their cost of money. Bond prices and yields move in opposite directions.

“The policy decision is a close one," said Rajan. He admitted that the current level of inflation is still high and that RBI had refrained from raising the rate considering both the “weak state of the economy" and the fact that the rise in inflation, driven by food prices, is likely to be temporary. “There is merit in waiting for more data to reduce uncertainty," the policy statement said, making it clear that Rajan would take a call after the December inflation numbers are released in mid-January.

However, WPI core inflation—the non-food, non-fuel manufacturing inflation measure—which is a key indicator of price movement, more or less stabilized at 2.66% in November (it was 2.64% in October). This trend, if sustains, will give room for RBI to embrace a benign policy environment, economists said.

Most economists are looking at the wholesale and retail inflation numbers for December and factory output numbers for November to gauge the possible direction of monetary policy.

“While RBI sounds quite confident about the key culprit (vegetable prices) coming down, if that doesn’t happen or if there is no notable reduction in core inflation in December (the latter is difficult in our view), we can expect a 25 basis points (bps) repo rate hike (likely the last one, in our view)," said Devika Mehndiratta, a senior economist for Asia Pacific at Australia and New Zealand Banking Group Ltd, in a note.

A basis point is one-hundredth of a percentage point.

Others echoed that sentiment. Taimur Baig and Kaushik Das, economists at Deutsche Bank AG, expect a 25 bps rate hike in January or even before the next policy. Further rate hikes will depend on how the inflation trajectory pans out, the Deutsche Bank economists said in a note. RBI’s next policy review is scheduled for 28 January.

“Vegetable (prices) inflation was a noise in the inflation data. That will come down now. But it is (too) early to say that inflation worries are over in the economy. Also, this doesn’t mean that rate hikes are over. The central bank has paused to assess the situation," said D.K. Joshi, chief economist at rating agency Crisil Ltd, the Indian subsidiary of Standard and Poor’s.

Leif Lybecker Eskesen, chief economist for India and Association of Southeast Asian Nations, HSBC Global Research, Singapore, said that if inflation continues to stay high, the central bank may have to raise rates going forward.

“We would argue that inflation risks remain tilted to the upside and that further monetary tightening is needed to manage these risks... Encouragingly, RBI signalled that it would stand ready to tighten (rates) if headline inflation does not ease significantly on the back of lower food inflation or core inflation does not fall," Eskesen said.

RBI itself cautioned that Wednesday’s pause doesn’t mean that there will be no more rate hikes.

“If the expected softening of food inflation does not materialize...the Reserve Bank will act, including on off-policy dates if warranted, so that inflation expectations stabilize and an environment conducive to sustainable growth takes hold," the central bank said.

The unexpected rate pause cheered industry lobby groups, which said this was much needed to prop up the economy.

“We are happy that RBI has taken cognisance of the weak state of the industrial economy and hope that the next move will be in the direction of lowering of policy rates," said Naina Lal Kidwai, president of the Federation of Indian Chambers of Commerce and Industry.

Keeping interest rates in check will also support stocks at a time when the government needs to sell stakes in state-controlled companies to help achieve a fiscal deficit of 4.8%, Kidwai said.

Chandrajit Banerjee, director general of the Confederation of Indian Industry (CII), said that the rate action supports growth. “CII has maintained that the current spike in inflation is a supply-side phenomenon and, therefore, a tight monetary policy would hurt growth while proving unequal to the task of tackling inflation."

BSE’s benchmark Sensex rose 1.5% while the National Stock Exchange’s broader Nifty index surged 1.58% in intra-day trading. The Sensex finally ended the day with a 1.2% gain at 20,859.86 points and the Nifty gained 1.27% to end trading at 6,217.15 points.

The yield on the 10-year benchmark bond fell 13 bps to 8.78% intra-day from its previous close before ending at 8.79%, while the Indian currency strengthened to 61.78 against the dollar, up 0.36%, before erasing its gains to close at 62.11, down 0.14%.

All rate-sensitive sectoral indices too jumped, with the Bankex, the index of major bank indices on BSE, rising 3.17%; the Realty index gaining 3.8%, and the Auto index advancing 2.02% in intra-day trading. The Auto index closed 1.73% up, the Realty index 3.51%, and Bankex 1.45%.

The biggest gainers on BSE included Housing Development Infrastructure Ltd, which rose 7.87% intra-day, Oriental Bank of Commerce (7.96%), Canara Bank (7.16%), Allahabad Bank (6.3%), DLF Ltd (6.19%) and Bank of India (6.1%).

The status quo in policy rates changes nothing for individual borrowers and corporation.

C. Rangarajan, chairman of the Prime Minister’s economic advisory council, and Arvind Mayaram, economic affairs secretary, said inflation is likely to ease by December, Bloomberg reported. Rangarajan, a former RBI governor himself, said the central bank is doing a difficult balancing act by managing the dynamics of inflation and growth.

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