RBI holds rate for now but warns of future hike

Sensex snaps losing streak; some experts fear RBI might soon have to do a catch-up job

 

The Reserve Bank of India (RBI) on Wednesday surprised the market by maintaining the status quo on interest rates in the mid-quarter review of its monetary policy. It, however, warned of a possible rate increase in the coming months if inflation did not come down. Markets, which had factored in a 25-basis-point repo rate increase, cheered the move but some experts said the central bank was in denial mode and might have to do a ‘catch-up’ job.

The repo rate was kept unchanged at 7.75 per cent and the cash reserve ratio — the proportion of deposits banks must park with RBI in cash — remains four per cent.

Following the RBI move, the BSE Sensex snapped a six-day losing streak to gain 240 points, or 1.2 per cent, over its previous close. Rate-sensitive stocks, such as those from the automobile, realty and banking sectors, outperformed the broader index.

Explaining the rationale for his decision to keep the repo rate unchanged, RBI Governor Raghuram Rajan said headline inflation had moved up lately but a decline in vegetable prices over the past few weeks was likely to cool inflation. Some stability in the exchange-rate market and sagging economic growth were also seen as factors that could have influenced the decision.

  Even as RBI has taken a pause on the rate front — after hikes in September and October — it has said it could act even on off-policy dates, if inflation does not come down in sync with its assessment.

“If food inflation does not soften and significantly bring down headline inflation in the next round of data releases, or if inflation excluding food & fuel does not come down, RBI will act — even on off-policy dates, if warranted — so that inflation expectations stabilise and an environment conducive for sustainable growth takes hold,” Rajan said.

The annual retail inflation rate accelerated to 11.24 per cent in November from 10.17 per cent the previous month. The wholesale inflation rate in the month stood at 7.52 per cent — a 14-month high — compared with seven per cent in October.

Corporate India has welcomed the central bank’s decision, but some economists argue it is core inflation that is more relevant and should have been taken into account while deciding on the policy stance.

“It does not matter what vegetable prices will be in January or February. What really matters is, where will be core inflation six to nine months down the line. All available forward indicators suggest that core inflation will go up in the coming months,” said Jahangir Aziz, chief Asia economist at JPMorgan.

Aziz compared the situation with that in 2011, when the central bank’s status-quo decision proved counterproductive and inflation increased in the months that followed. “RBI again appears to have got the inflation drivers wrong. It is not food but core inflation; we now have a situation similar to 2011, when RBI spent the year playing catch up with inflation,” Aziz said. According to market players, keeping the rate unchanged may not be possible for long; RBI may have to raise it in January.

“In our view, today’s decision is akin to RBI hitting the snooze button on rate hikes and not an end to the hiking cycle. We maintain our view of a cumulative 50-basis-point repo rate increase in the first half of 2014,” Nomura said.

India Inc termed the decision a move in the right direction. “The rupee has stabilised and the fuel prices, too, will not increase in a hurry. To an extent, these obviate the need for monetary tightening. So, RBI has demonstrated restraint and foresight to strike the right balance between inflation and growth,” said CII Director-General Chandrajit Banerjee.

Rajeev Talwar, executive director of real estate company DLF called the development the first sign of recovery for the Indian economy. “If the government releases enough food stock in the market, food inflation will come down; we can expect better response from the RBI governor. He has done extremely well to withstand any compulsion to hike the rate,” Talwar said.