It was the fast forward button that the Reserve Bank of India (RBI) chose to press on Tuesday in its fight against inflation, convinced that there is as yet ?no evidence of a sharp or broad-based slowdown? in growth. Indicating that it would be concerned only if ?growth fell significantly below trend?, the central bank upped the key repo rate by a steep 50 basis points to 8%; the move shocked industry and sent the Sensex crashing 353 points. The yield on the ten-year benchmark bond soared to 8.44% as bankers resigned themselves to another round of loan rates hikes, costlier money and slower credit growth.
Said Aditya Puri, MD and CEO, HDFC Bank: ?Yes, there will be an increase in interest rates since costs are going up. Moreover, we also have to take into account RBI?s view that demand pressures continue to stoke inflation.? Over the past year, borrowers have seen the cost of their loans go up by about 100-150 basis points while savers have earned about 100-150 basis points more on their term deposits.
With the RBI leaving the growth forecast for 2011-12 unchanged at 8%, no one was in doubt that there are more rate hikes to come. Observed Rohini Malkani, economist at Citibank: ?The RBI has stated that a change in its anti-inflationary stance ?will be motivated by signs of a sustained downturn in inflation?. With inflation likely to remain elevated, this seems unlikely in the near future and we could see a further tightening of about 50 basis points by December.?
Reiterating that anchoring inflationary expectations remained the central bank?s priority, RBI governor Duvvuri Subbarao pointed out that demand pressures remain strong with actual inflation higher than expected and the possibility of it remaining elevated given the impact of higher fuel prices and minimum support prices for food. ?The current balance of global and domestic factors suggests that monetary policy needs to persist with a firm anti-inflationary stance,? the governor asserted in the first quarter review of the monetary policy.
That the RBI doesn?t expect the rise in prices to moderate in a hurry is clear from its raising the inflation forecast for 2011-12 to 7% from the earlier 6%; the central bank still believes the GDP for the current year could come in at 8% although it has pruned the non-food credit growth target for the banking system to 18% from 19% earlier, a move clearly aimed at curbing demand. In fact, even in May this year, the RBI had forecast growth for 2011-12 in the range 7.4-8.2% implying that the central bank is not uncomfortable with lower growth. ?Early corporate results for Q1 of FY11-12 suggest some moderation in margins; however, such moderation so far has been modest, implying pricing power persists,? Subbarao observed. The governor chided the government for not doing its job, saying reining in the fiscal deficit to 4.6% of GDP for 2011-12 could be much more of a challenge than anticipated, given subsidies. ?The large fiscal deficit has been a key source of demand pressures. Fiscal consolidation is, therefore, critical to managing inflation,? Subbarao said, adding that a shift away from consumption to investment would help.
While noting that investment needed to pick up, the RBI governor said while there are signs that growth is beginning to moderate, particularly in respect of some rate-sensitive sectors, several indicators such as exports and imports, indirect tax collections, corporate sales and earnings and demand for bank credit suggest that demand is moderating, but only gradually. ?As such, demand side inflationary pressures continue to prevail. Although the impact of past monetary policy actions is still getting transmitted, considering the overall growth and inflation scenario, there is a need to persevere with the anti-inflationary stance,? the RBI asserted.