That RBI would raise interest rates was almost certain, but by how much was a matter of conjecture for the market participants. A 25-bps increase in repo, reverse repo and CRR clearly did not shock market participants. I do not expect interest rates to be impacted much by RBI action in the near term. By the second half of the fiscal, however, yields on the 10-year govt paper should firm up to 8.3-8.5 per cent as demand for private credit picks up and pressure from government borrowings continues. Over the last few months, inflation has not only risen, but has also got broad-based.
This has been accompanied by a steadily improving growth scenario. Consequently, the growth-inflation trade-off has become more marked. The policy rates at present, however, continue to be much lower than what can be regarded as the 'normal' levels in the context of inflation and growth outlook. In such a scenario, RBI needed to hike interest rates sharply than they did today. However, there was an equally compelling reason for RBI to avoid fasttracking the process of interest rate normalisation —the orderly conduct of government borrowing programme. RBI has chosen the middle path by continuing with a gradual hike in interest rate.
The RBI's growth target of 8 per cent for 2010-11 seems achievable. The risk is on the inflation front. Last year, RBI had to consistently revise its year-end inflation target upwards in each subsequent policy. If monsoon is normal and global commodity prices do not increase further, WPI-based inflation will peak soon. In this scenario, inflation will decrease to around 6-6.5 per cent by March 2010, in my opinion. This is a tad higher than RBI's expectation of the fiscal year-end inflation at 5.5 per cent. If the risk to inflation materialises and it surprises on the negative side, as it did last year, RBI will have to resort to a much tougher monetary stance later on. RBI's action in its April policy implies that this is a low probability event in their prognosis.
