Elevated headline prints, large upward revisions, and rising ‘core’ inflation (non-food manufacturing inflation breached 7 per cent year-on-year in March to hit a 29-month high) would certainly force the Reserve Bank of India (RBI) to continue tightening in 2011-12 with a front-loading bias. Missing the 2010-11 inflation projection by a wide margin, even after frequent revisions, would result in the central bank being more cautious in 2011-12. We expect a cumulative hike of 75-100 basis points in repo and reverse repo rates by September (including a rise of 25 basis points next week).
However, preference for calibrated tightening and the current six-week frequency of policy meetings would, perhaps, mean a rise of 25 basis points at a time in the meetings, rather than a rise of 50 basis points in a single instance.
RBI is likely to prefer keeping liquidity under a tight leash as well. Systemic liquidity was under strain during most of 2010-11, reflecting huge demand for currency due to high inflation, the government’s rural spending, and the slower primary liquidity creation by RBI. Similar factors could prevail for most of 2011-12 and consequently, continue to weigh on liquidity in the banking system.
High inflation, tight liquidity and the probable aggressive tightening could affect manufacturing and construction activities the most. It is interesting to see whether RBI’s 2011-12 growth forecast would deviate significantly from the government’s aggressive 9 per cent forecast announced earlier.
However, even a weaker growth rate would not necessarily offer any respite on the inflation front, as domestic prices continue to face the threat of second-round effects from rising input costs and energy prices. Average inflation in 2011-12 is likely to settle higher than the central bank’s usual comfort zone (typically 5-6 per cent). Overall, there is no respite in sight for interest rates, especially front-end rates.
The writer is Chief India Economist, Barclays Capital
