As inflation rises unabated, market expects 25-bps hike in repo rate

Written by fe Bureau | Mumbai | Updated: Dec 17 2013, 08:25am hrs
The Reserve Bank of India (RBI) is widely expected to hike the repo rate by 25 basis points to 8% at its mid-quarter policy review on Wednesday owing to a rise in inflationary pressures, both in the wholesale and retail segments.

Most analysts believe that the central bank would have to hike rates one more time before 2013-14 comes to an end. Out of the 10 economists polled by FE, eight expect a cumulative 50-bps hike from the RBI by March end.

The RBI has already hiked the repo rate by a cumulative 50 bps in 2013-14 so far, citing sticky inflation. Bond dealers too have already priced in a hike on Wednesday followed by a possible hike again in January. The yield on the benchmark 10-year 8.83%, 2023 bond has risen by 7 bps to 8.87% in the last one week on such expectations.

Economists said a retail inflation of over 11% in October and a 14-month-high WPI inflation has increased the threat to an already slowing growth. The upside surprise in both CPI and WPI inflation for November leaves no option for RBI, but to hike the policy rate by 25 bps in Wednesdays monetary policy review, said Taimur Baig, chief economist at Deutsche Bank in a report.

Even though the contraction in industrial output queers the pitch for rate hikes slightly, inflation risks are overwhelming, economists said. I think the gamechanger for growth would be to get inflation under control, said Leif Eskesen, chief economist, HSBC.

RBI will have to maintain their tightening stance for now. We may see one more hike early next year given the inflation situation, he added.

The index of industrial production (IIP) showed a contraction of 1.8% in October as manufacturing activity shrank. India's GDP growth has been slowing each consecutive year since 2010-11 and had slowed to a decade low in 2012-13, slipping below 5%. For July-September this fiscal year, GDP growth was 4.8% and most economists peg growth for the full year to be around 5%.

Even as growth continues to flounder, CPI inflation has surged to 11.24% in October while WPI inflation has risen to a 14-month high of 7.24% in November. The rise in both the retail and wholesale inflation were mainly driven by food inflation.

Although a significant part of the CPI print has been driven by perishable items, RBI is likely to find it difficult to ignore the double digit CPI print, said Shobhada Rao, chief economist, Yes Bank.

Despite much of the inflationary pressure emanating from food, economists believe the RBI will have to hike rates amid a slowing economy as persistent food inflation tends to get more generalised as seen in the past.

Also, RBI governor Raghuram Rajan had indicated that the central bank would expect the CPI inflation to come down to 9%, indicating that retail inflation has gained more weight in policymaking now.

Further, core inflation has also risen to 2.7% in November from 2.6% the previous month and is expected to rise further due to a low statistical base. The RBI has projected a GDP growth of 5% for 2013-14, but has refrained from a clear projection on inflation.