We had expected the Reserve Bank of India (RBI) to raise policy rates by 25 basis points today, as it did. First, while inflation is peaking, it would persist at nine-10 per cent levels till October. Second, although high rates continue to bite, growth in the quarter ended June stood at a decent 7.7 per cent. Third, though rates are impacting the demand for loans, credit growth, at 20.7 per cent, is currently above RBI’s projection of 18 per cent for 2011-12. Fourth, global commodity prices are still holding up in expectation of further US monetary easing on September 21. Finally, although the global situation is very fluid, a recession is not cast in stone.
Looking ahead, we expect RBI to pause after raising policy rates by 25 basis points in October. After all, rising rates have already pulled down growth below the estimated eight per cent potential growth rate. The growth would likely slip below 7.5 per cent in the coming quarters. This should defuse ‘overheating’ risks. Second, M3 growth (growth in cash and bank demand and time deposits), at 16.4 per cent, is running below the optimal 17.5 per cent levels, containing demand-led inflation. Third, loan demand would likely slip to 17 per cent, owing to the rising rates. Fourth, we assess the inflationary impact of QE-III, at 50-100 basis points, would likely be below QE-II’s 150 basis points, as most commodities inflation in India is sensitive to, now face a more favourable demand-supply balance. Finally, the likelihood of a US recession is now 40 per cent.
Indranil Sengupta
Chief economist (India) Bank of America Merrill Lynch
