RBI may raise rates in October

ANALYST'S VIEW

A risk on the horizon for some Asian ex-Japan economies is inflation. In 2008, inflation in China, India, Hong Kong and Singapore may surprise on the higher side due to domestic rather than global factors.

However, the demand side pressures are limited, monetary growth is within tolerable limits and inflationary expectations are anchored in the region's other countries.

Besides the domestic drivers of inflation, there is limited evidence to suggest that global output gap matters for inflation in the region. But what matters are commodity prices and transport costs. There is a risk that the influence of Asia as a source of disinflation for the rest of the world could be moderating.

The common ultimate drivers of inflation in China, Hong Kong, India and Singapore are the output gap and lagged inflation.

These are economies where demand side pressures resulting from a positive output gap are probably the strongest, labour market has tightened rapidly and core inflation is rising.

The monetary indicators in China and India are flashing red and may induce further inflationary pressures in the next 12 months.

Our average wholesale price index (WPI) inflation forecast for India in FY 2007-2008 is 5.5 per cent versus the consensus 5.2 per cent. For end-March 2008, our WPI inflation forecast is 5.4 per cent.

We expect a moderation in inflation in the first five months of FY07/08 due to base effects, a seasonal drop in food prices resulting from a normal harvest in the agriculture sector in March and April, and slower economic activity during these months.

Looking beyond August 2007, we expect inflation to accelerate till December 2007 and to moderate to some extent in the January to March 2008 period.

The lagged impact of strong domestic demand, real M3 growth and past price pressures is the key factor behind our inflation forecasts. As a result, we expect the RBI to hike the repo rate by 25 basis point at each of the credit policy review meetings in October 2007 and January 2008 to bring the repo rate to 8.25 per cent.

We also expect a hike in the cash reserve ratio by 50 basis points to 7.5 per cent by end-2007, if liquidity conditions were to remain flush.

This is conditional on the fact that global financial market jitters would recede in the coming months.

""Credit Suisse report on Asia Ex-Japan inflation