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RBI's new boss Raghuram Rajan has achieved his first objective -- normalisation of policy rates -- in less than two months. With Tuesday's 25 basis point increase in repo to 7.75 and cut in the marginal standing facility rate by 25 basis points to 8.75%, Rajan has bring the gap between the two rates to 100 basis points. Other than this, he has painted a rather grim picture. Tuesday's policy statement is hawkish and the central bank is now not even pretending to look focus on growth as both wholesale and retail prices remain elevated. Even though the WPI print of September at 6.5% levels is closer to the central bank's comfort level, nobody quite expects the RBI to cut rates anytime soon as it expects both the retail and wholesale price inflation to remain elevated through the year.
Even though market participants have been clamouring for a rate cut, Rajan's message is clear -- achieving macro-economic stability is his first priority. Kruti Shah, economist at Karvy Stock Broking, says Rajan has taken away the feel-good picture painted by his predecessor D Subbarao whilst cutting rates earlier this year. She says: "The outlook on growth remains negative as there is a 40% chance of a rate hike if inflation does not cool off meaningfully." GDP growth could fall below 4.8% in FY14 if the central bank hikes rates further due to price pressures. The market expects the RBI to maintain status quo in December too even if food inflation comes off. Food prices, which rose 42% year on year in urban areas and 31% in rural areas, have primarily driven up the inflation print for September. With the onset of winter, vegetable prices may ease but this may not be sufficient to warrant a rate cut.
Sonal Varma, economist at Nomura, says: "Looking ahead, the repo will be made the operational rate once oil demand is brought back to the market and repo rates are hiked to a “reasonable level” to ensure a positive real return to savers. With CPI inflation close to 9.5% and deposit rates in an 8-9% range, positive real return to savers still calls for a further hike in the repo rate, unless CPI falls sharply, which appears unlikely at the moment. We pencil in another 25 basis point hike in the repo rate to 8% by March 2014."
The policy statement says while food price pressures may ease with the arrival of the kharif harvest and the usual seasonal moderation, overall WPI inflation is expected to remain higher than current levels through most of the remaining part of the year, warranting an appropriate policy response. Retail inflation (CPI) too has risen sharply across food and non-food constituents, including services, keeping inflation expectations high. Even though food prices, especially prices of vegetables tend to fall during the winter season, but the RBI is not banking on any easing in retail inflation as expects it to "remain around or even above 9% in the months ahead, absent policy action."
Even if prices cool off, as some economists expect, in the first quarter of calendar 2014, a rate cut will be difficult as the spectre of a US taper continues to loom over emerging markets. The currency may have stabilised at current levels, but the risks are far from over.
