Hawkish RBI raises inflation forecast to 8%, increases key rates by 25 bps.
The message from the country’s central bank is loud and clear: Expect a series of policy rate increases through the next financial year, as inflationary pressures have accentuated, even as risks to growth are emerging.
In its mid-quarter monetary policy review on Thursday, the Reserve Bank of India (RBI) increased key policy rates by a quarter point – the eighth increase in a year – warning that rising oil prices will put more pressure on the already high inflation. This was on expected lines. The repo rate – RBI’s short-term lending rate – has gone up from 6.5 per cent to 6.75 per cent with immediate effect. The reverse repo rate – its short-term borrowing rate – has risen from 5.5 per cent to 5.75 per cent.
But what worried the markets was the hawkish tone adopted by RBI while raising its wholesale price inflation forecast for the year to 8 per cent, a full percentage point higher than the number in the third quarter review in January. RBI said rising global commodity prices, particularly of oil, were a major contributor to inflationary pressures. Domestic fuel prices, which were yet to fully adjust to the global prices, might put further pressure on inflation, it said.
| NOW, PAY MORE FOR LOANS | |
| RBI’S ACTION | MARKET REACTION |
| * Policy rates raised by 25 bps | * Lending rate rise imminent; deposit rates have peaked |
| * Upward risks to inflation | * Rate rises of 50-75 bps expected in FY12 |
| * Slowdown in investment momentum | * Growth estimate lowered |
| * Yet to assess Japan crisis impact | * Increased uncertainty |
“Based on the current and evolving growth and inflation scenario, RBI is likely to persist with the current anti-inflationary stance,” the central bank said.
RBI clearly articulated the risks to growth from high inflation. “The continuing uncertainty about energy and commodity prices may vitiate the investment climate, posing a threat to the current growth trajectory,” it said.
Financial sector pundits are thus no longer debating whether there will further rate rises. Their discussions centre on how much. “RBI’s stance clearly makes a case for front-loading rate hikes to cool inflation. RBI is likely to squeeze in more rate hikes in the first half of the next financial year. We may have three to four hikes of 25 basis points each between April and September,” said HDFC Bank Chief Economist Abheek Barua.
Goldman Sachs’ Chief India Economist Tushar Poddar said RBI was expected to raise policy rates by another 50 basis points in 2011, starting with the next round in May.
The reaction from the equity markets was on expected lines, with the Bombay Stock Exchange Sensex declining 1.1 per cent, led by financial sector stocks. RBI’s move disappointed business leaders, who said the rising cost of finance and materials was weakening confidence and crimping growth.
Banks are likely to respond by raising lending rates, though the consensus seems to be that deposit rates (most banks are offering between 9.25 per cent and 10.25 per cent) have peaked. Also, higher interest rates will affect loan demand in the first few months of the financial year, which is a slack reason.
State Bank of India Chairman O P Bhatt said banks’ cost of funds was expected to rise, leading to an upward bias in interest rates.
HDFC Bank Managing Director Aditya Puri said deposit rates had already peaked. “There could be more lending rate hikes. I think there could be a maximum 50-75 basis points hike. It will depend on individual banks. We recently raised our deposit rates. We will take a considered view on lending rates,” he added.
Canara Bank Chairman and Managing Director S Raman said banks would revise lending rates. “There could be a 25-basis-point increase in lending rates. We will review our rates shortly,” he said.
RBI said the pace of credit expansion had moderated since December due to rate hikes by banks. Banks have increased their base rate, the reference rate for loans, by close to 150 basis points in the last six months.
RBI said the Budget’s fiscal deficit numbers gave comfort, but a potential increase in subsidies on petroleum products and fertilisers as a result of high crude oil prices could put pressure on expenditure.
“It is critical, therefore, to focus on the quality of expenditure, keeping the aggregate under control, without compromising the delivery of services. Only then can the fiscal situation contribute to the demand-side inflation management,” RBI said.
The concerns on the current account deficit have come down significantly with robust export performance. As a result, RBI revised downwards its current account deficit projection for 2010-11 to 2.5 per cent of the gross domestic product.
RBI said it was too early to assess the impact of the natural disaster in Japan on India’s economy, but warned that a turn from nuclear energy could exert further upward pressure on petroleum prices.
