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Despite the Reserve Bank of India (RBI) saying additional rate rises will not be required if the inflation trajectory showed a decline, experts foresee at least another rise in rates in the next six months.
“The extent and direction of further policy steps will be data-dependent, though if the disinflationary process evolves according to this baseline projection, further policy tightening in the near term is not anticipated at this juncture,” RBI said on Tuesday, while raising the repo rate for the third time in five months. Since September 2013, the rate has been raised by 75 basis points.
Markets, which stabilised after an initial knee-jerk reaction, interpreted the comment as a signal for a pause.
However, economists weren’t too sure. “While we expect CPI (Consumer Price Index)-based inflation to moderate in the coming months on lower vegetable prices and base effects, we do not see headline CPI inflation sustaining below nine per cent, given the structural bottlenecks in food and the re-emergence of inflationary pressures in rural areas. Thus, we expect interest rates to continue to inch higher; we see another 25-basis-point repo rate hike to 8.25 per cent in the first half of 2014,” said Sonal Varma, economist at Nomura.
The central bank also highlighted upside risks to its CPI inflation projection of eight per cent, as suggested by the Urjit Patel committee, through a 12-month period.
CPI inflation fell to a three-month low of 9.87 per cent in December 2013, compared with 11.16 per cent a month earlier. While Wholesale Price Index (WPI)-based inflation stood at a five-month low of 6.16 per cent in December, it was 7.52 per cent in November.
A few economists say core inflation (inflation that doesn’t factor in food and fuel prices) may continue to remain high. “Core inflation is far too high and a decline in the near term is not on the cards. Inflation expectations remain elevated and we do not see sufficient slack in the economy to bring core inflation down notably. Lack of structural reform and infrastructure investment has done serious damage to the economy’s growth potential. Moreover, bringing inflation down to six per cent in two years will require further tightening. We have, therefore, pencilled in at least another 25-basis-point rate rise between now and summer, even if RBI switches to a monitoring mode for now,” said Leif Eskesen, chief economist for India and the Association of Southeast Asian Nations, HSBC Global Research.
In December 2013, core inflation stood at about eight per cent, an uncomfortable level, according to RBI.
In 2014-15, the central bank expects a modest recovery in economic growth. However, it cautioned inflation risks might continue, despite the moderation in prices in recent weeks. It scaled down its growth forecast for this financial year to below five per cent, against five per cent earlier. RBI expects five-six per cent growth in 2014-15.
“A moderate-paced recovery is likely to take shape in the next year, with support from rural demand, a pick-up in exports and some turnaround in investment demand. The growth in 2014-15 is likely to be in the range of five-six per cent,” the banking regulator said in its report on the third-quarter review of macroeconomic and monetary developments.
The central bank said the pace of growth might accelerate beyond five-six per cent if project clearances translated into investment, the outlook on global growth improved and inflation softened.
"Despite moderation in December and some further softening expected in near-term, inflation risks have to be watched carefully as we enter into the next year. This is due to upward revision in domestic energy prices, expected growth acceleration, structural bottlenecks affecting food inflation and adverse base effects," RBI said.
