With inflation reaching a plateau and in Reserve Bank of India's (RBI) own terms, 'normalisation as a motivation for further action is likely to be less important', market participants expect the central bank to go in for one more round of rate increases before hitting the pause button.
This is because the central bank believes inflation remains a dominant concern, as it will be at unacceptably high levels for some months. Hence, there is need to continue with policy responses to contain inflation and anchor inflationary expectation.
Headline inflation rate, as measured by the Wholesale Price Index (WPI) with a revised base of 2004-05, decelerated to 8.5 per cent in August, primarily due to fall in prices of primary articles, compared to 9.8 per cent in the previous month.
"Given the industrial growth and inflation, perhaps one more rate hike, at most, is expected till the end of the current financial year. I expect the RBI to pause on rate hike in November and maybe wait till January," said Abheek Barua, chief economist, HDFC Bank.
Similarly, Sonal Verma of Nomura Securities, said, "With monetary conditions tightening and global demand still sluggish, we retain our view that growth and inflation are likely to moderate in the coming quarters and that the RBI is close to pausing in its rate hiking cycle."
The case for rate raise, at least for once, is also due to the central bank's effort to end the regime of negative real interest rates. "The policy actions taken over the past three quarters have been partly motivated by the need to end the prevalence of (such) rates. This was sought to be accomplished by a combination of increasing policy rates in a non-disruptive manner and declining inflation rates. Both factors are at work, but the process is still incomplete," RBI said.
Though there is agreement among market watchers that sooner or later RBI will press the pause button, the debate is on the timing. If RBI stops rate raises from November, interest rates will be stabilising in the neutral zone.
"We continue to expect RBI to pause after raising the reverse repo rate by 25 bps on November 2, with inflation peaking off. The focus of RBI policy will need to turn, sooner than later, to injecting liquidity to fund loan demand," said Indranil Sen Gupta, economist with Bank of America Merrill Lynch (BofA-ML).
Noting that normalisation or close to the normal monetary situation is already achieved, Barclays Capital expects no further rate raises in the current fiscal year. "We believe the Reserve Bank has finished raising the repo rate, but has left a small window open for further action on the reverse repo rate, especially given the priority of narrowing the corridor," went its report.
Inflation projection
The question being asked now is whether the central bank will revise the inflation projection in its November policy, given the inflation-reaching plateau. HDFC Bank feels RBI may revise its end-March inflation projection downward to 5.5 per cent in November. BoAML sees inflation coming down to seven per cent by December and 5.7 per cent by March 2011.
During the first quarter review of monetary policy in July, RBI raised its inflation projection to six per cent by March end.
Economists suggest the central bank may choose to revise its projection downward also because of the new WPI series, now used for arriving at headline inflation. The new series, based on 2004-05 data, is more broad-based and relevant.
RBI, however, says though the inferences from both the old and new series are similar and the direction of the inflation rate movement is consistent with its projection made in the July review, the magnitude could be slightly different.
