Despite acknowledging that global economic conditions have worsened appreciably in recent weeks, the Reserve Bank of India (RBI) raised the repo rate by 25 basis points again, raising it to 8.25 per cent, in line with our expectations. The RBI justified its stance, saying the underlying inflation pressure was still above its comfort level. It said compared to growth risks, this posed a bigger threat to the economy.
While the domestic growth momentum has moderated in recent months and may well pose a downside risk to RBI’s eight per cent growth projection for 2011-12, controlling inflation and inflation expectations still remains the priority, according to the central bank’s assessment. While the wholesale price index (WPI) inflation may have peaked in August to 9.8 per cent, we do not expect a sharp moderation in the inflation trajectory before December. At nine per cent, WPI inflation would remain elevated at around nine per cent in the next three months and probably moderate to seven-7.5 per cent by December, helped by a positive base effect. So, according to our assessment, barring any further deterioration in global market conditions leading to a significant fall in global crude oil prices, another 25-basis point rate hike by RBI is still possible in the monetary policy review in October. This should mark the end of the current rate rise cycle. Beyond this, we think RBI would pause, taking comfort from a likely downward-moving inflation trajectory from November.
We expect the pause to persist till May. RBI could then look to cut rates from June, as inflation heads to a six per cent trajectory, while growth concerns accentuate further. This scenario is subject to the risk that commodity prices head up again (although on a year-on-year basis, we see them remaining flat even in a bullish scenario) or domestic rigidities conspire to keep inflation above seven per cent. In that eventuality, there would be no room for rate cuts in 2012.
Gunit Chadha
CEO, Deutsche Bank India
