With inflation showing no signs of changing its trajectory, the Reserve Bank of India (RBI) is set to raise the key policy rate by another 25 basis points, when it reviews the monetary policy on Tuesday.
Inflation, based on Wholesale Price Index, is hovering around 10 per cent for 20 months now, despite 350 bps increase in the repo rate — which is at 8.25 per cent now — since March, 2010. The repo rate which has been raised 12 times in the last 19 months has resulted in growth moderation.
“Despite the moderation in growth, inflation is not coming off its highs and is set to remain elevated as underlying inflationary pressures remain firmly in place as excess demand should only gradually dissipate. Against this backdrop, RBI should still, on balance, consider inflation the dominant concern and, therefore, continue to tighten, giving the repo rate a 25bp lift on Tuesday,” said Leif Lybecker Eskesen, Chief Economist for India and ASEAN, HSBC Global Research.
Economists say the central bank may cut its GDP growth forecast for the current financial year as the past rate hikes have already started to hurt growth. During the past three reviews following the annual review in May, RBI maintained its GDP forecast at eight per cent. However, in the last policy review in September, RBI said there is a downside risk of the growth projection of 8 per cent.
“We now expect FY12 growth to slow to 7.4 per cent against our previous forecast of 7.7 per cent and 8.6 per cent a year ago .This reflects both our anticipation of stronger cyclical headwinds stemming partly from global growth but also lingering policy impediments and supply bottlenecks the persistence of which could further derail domestic investment and long-term growth potential” said economists at HDFC Bank in a research note. HDFC Bank lowered its industrial production growth for FY12 to five per cent from six per cent projected earlier while agricultural growth forecast revised upward to 3.5 per cent from three per cent due to favourable monsoon.
Amid slowdown in economic growth and expectation of inflation trajectory changing direction from December, experts said October 25 may be the last of the current rate increase cycle.
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“We don’t see further policy tightening from RBI post the October review, as we expect inflation to head lower to eight per cent by December 2011, in the absence of any further supply shocks,” said economists Taimur Baig and Kaushik Das of Deutsche Bank. RBI projects inflation to come down to seven per cent by March, 2012.
Though there is a consensus among market participants that RBI will take a pause after raising the key policy rate on Tuesday, but it is unlikely that the central bank will drop its anti-inflationary stance by indicating a pause, a strategy it had adopted exactly a year back, but backfired.
“RBI will want to avoid a repeat of late 2010, when a pause in the tightening cycle caused inflation to flare up again. As a result, RBI is worried about ‘prematurely’ exiting from its anti-inflationary stance. Hence, the statement is on focus, leaving the door open for another raise if the need arises,” said Anubhuti Sahay, economist, Standard Chartered Bank.