The signs that a rate rise was imminent were more than clear. The only question was by how much. Many had expected the Reserve Bank of India (RBI) to raise the rates by an aggressive 50 basis points, as it did in May. However, the regulator has taken into account the softening in the global economic environment and the moderation in domestic economic activity. It seems to have decided to raise rates in a gradual manner.
The repo rate has been raised by 25 basis points to 7.5 per cent and consequently, the reverse repo is now 6.5 per cent.
Despite growth showing early signs of cooling, and food and energy prices easing, core inflation has remained stubbornly high. May wholesale price index inflation rose to 9.1 per cent year-on-year, against 8.7 per cent in April, justifying the concern over inflationary pressures.
The rise should also be seen in the context of the fact that while there is a moderation in growth, the momentum is still quite solid, as evident from the fourth quarter results.
We think the repo rate would rise to 8.25 per cent by early 2012 and expect increases in the reserve requirement ratio. However, with inflation pressures a constant threat, RBI may need to front-load the remaining increases.
Markets and the industry have, naturally, been worried another rate rise would further hit domestic growth. However, the pace of growth, at 7.8 per cent in the fourth quarter of 2010-11, while lower than the 9.3 per cent recorded during the same period in the previous year, still remains good and demand in most sectors, barring a few interest-sensitive ones like automobiles, remains robust. This provides a reason for cheer and optimism. Effective medicines are often bitter and have temporary side effects. The case is similar with temporary rate increases — they are necessary to cure the ills of inflation, which currently plague the domestic economy.
Having said that, the truth is the fact that monetary policyis but one tool in the fight against inflation. While the regulator wields the rate increase weapon to dampen demand-led inflation, the government and policymakers have to focus on issues like capacity constraints due to infrastructural and supply chain concerns and create an environment that would encourage the industry to invest and, thus, ease supply-side pressures.
The writer is chief executive officer, HSBC India
