RBI expected to hike rates again4 min read . Updated: 21 Oct 2011, 04:10 PM IST
RBI expected to hike rates again
RBI expected to hike rates again
Mumbai: The Reserve Bank of India (RBI) is likely to raise interest rates again on Tuesday, but that doesn’t necessarily mean it should.
This would be the 13th rate rise since March 2010 for the RBI. It defies the growing case for standing pat as local and global conditions worsen, adding to the prospect it may be forced soon to reverse direction.
The RBI has come in for criticism from economists and investors for not acting more decisively earlier in the fight against inflation.
Continuing to raise rates delivers diminishing returns in the fight against inflation, which has remained above 9% for 10 straight months, some say.
“It is like a disease which has developed complete resistance to a certain antibiotic, so an additional dose is not going to do much good," said Rupa Rege Nitsure, chief economist at Bank of Baroda in Mumbai.
The RBI has lifted policy repo rate to 8.25%, its highest since just before the global financial crisis of 2008, but has been powerless to curb inflation driven in large part by supply bottlenecks, global commodity prices and loose fiscal policy.
It has, however, managed to crimp big-ticket spending on cars and housing, and, more ominously, capital spending that would add the capacity India needs to accommodate its ambitions for double-digit growth without overheating.
Investment has also been curbed by a slowdown in project approvals caused by political gridlocks.
Bank lending grew at 19.5% annually in late September, above RBI projections of 18% but below the 24% peak seen in December last year.
“Whatever capex or term loans disbursements are happening, most of these were tied up some time back," Paresh Sukhtankar, executive director of HDFC Bank, told reporters on Wednesday. “There isn’t too much of incremental flows from corporates for new projects."
Growth is slowing sharply in Asia’s third-largest economy, with some economists predicting it to drop below 7% in coming quarters. A recent Reuters poll forecast growth in the current fiscal year would fall to 7.6%, from 8.5% last year.
Industrial production for August rose by a weaker-than-expected 4.1%, continuing the slide from last year’s double-digits. Manufacturing PMI slipped in September to its lowest since March 2009, while services PMI shrank for the first time in more than two years.
“Growth is definitely slowing more than expected and in such a situation staying on hold itself is anti-inflationary," said Ramya Suryanarayan, economist at DBS in Singapore.
While exports remain a bright spot for India, they are imperiled by weakening demand from the United States and Europe, which are sliding towards recession.
Slowing growth domestically is adding to pressure on government finances. Expectations that New Delhi will fall short of its deficit-trimming goal and increase market borrowing have pushed up interest rates, and in turn borrowing costs.
A rate increase next week would only worsen the situation.
Raising rates again on Tuesday will undermine investor sentiment and exacerbate the slowdown at home without addressing supply shortfalls.
The RBI has been among the most aggressive central banks globally, and it’s tough stance makes it an outlier as countries such as Indonesia and Singapore have eased monetary policy and others have indicated they may do so soon.
“If the RBI continues to hike rates at this stage, demand would deteriorate further, banks’ credit quality will go down, net non-performing assets (NPAs) could rise and further lead to overall growth slowdown," said Nomura economist Aman Mohunta.
Meanwhile, the delayed impact of India’s cumulative tightening over nearly two years as well as a possible easing in commodity prices because of global slowdown is likely to begin bringing inflation down in coming months.
“We think that the RBI may be over-tightening, given that there is a significant demand slowdown, and we see little inflationary pressures going into FY13," Goldman Sachs economists wrote in a note on Thursday, referring to the fiscal year that begins in April.
While economists believe the RBI is at or near the end of its tightening cycle, they expect it to begin cutting rates only when inflation shows a steady decline, or if there is a global crisis.
“I don’t expect the Reserve Bank of India to go on a rate cutting spree unless there is a major negative development on a global front. They will either hold at current levels or hike on Tuesday and hold it there for sometime," Nomura’s Mohunta said.
Recent hawkish talk from government and the RBI officials has reinforced expectations that RBI governor Duvvuri Subbarao will lift rates, probably for the last time in the current cycle, next week.
“When inflation is remaining at the level which is way above the comfort level of central bank ... it becomes absolutely essential for the central bank to act," C. Rangarajan, the chief economic adviser to Prime Minister Manmohan Singh, said on Thursday.
Inflation data this week also provides little comfort that price pressures are poised to ease. The food price index rose 10.60% in the year to 8 October and the fuel price index climbed 15.17%, data on Thursday showed, up from 9.32% and 15.10%, respectively, a week earlier.
“Monetary policy has a role to play only up to a point and after that interest rate hikes will stop having an impact," said Bank of Baroda’s Nitsure.