Given the magnitude of upside in inflation data for February, which came in at 8.3%, it was not surprising that the Reserve Bank of India (RBI) raised key policy rates by 25 basis points each on Thursday, even though the central bank did caution that ?risks to growth are emerging?.
Indeed, the RBI has upped its wholesale price index-based inflation projection for March 2011 to 8% from 7% and its tone remains hawkish with economists sensing that there could be another rate hike in early May. With Thursday?s hike, the repo rate has gone up by 200 basis points since last March, taking it to 6.75% while the reverse repo rate has risen 250 basis points to 5.75% in the same period. The market would have been grateful for some guidance on the inflation trajectory in 2011-12 but none was forthcoming.
The RBI is comfortable with the current account deficit which is now expected to come in at around 2.5% of GDP, given the strong exports growth. The RBI, however, believes that a potential rise in subsidies could pressure expenditure, though the budgeted fiscal deficit for 2011-12, it says, gives comfort on the demand front.
Although the RBI noted that the ?weak performance of capital goods in IIP suggests that investment momentum may be slowing down?, the central bank will persist with the current anti-inflationary stance, especially since demand side pressures are escalating. ?Underlying inflationary pressures have accentuated and as domestic fuel prices are yet to adjust fully to global prices, risks to inflation remain clearly on the upside, reinforced by the persistence of demand side pressures as reflected in non-food manufacturing inflation,? RBI observed.
The approach to tightening money, however, should remain calibrated. ?We expect rates to be tightened by 75 basis points by early 2012. But upside risks to inflation could result in front-loading and perhaps an extension of the rate hike cycle,? observes Rohini Malkani, economist at Citigroup. Adds Samiran Chakraborty, Head Research India, Standard Chartered: ?RBI is continuing with its anti-inflationary stance but it?s also highlighting clearly, for the first time, that there are growth risks. Nevertheless, we expect two more rate hikes, one in May and probably one in June.?
Adds Saugata Bhattacharya, senior vice-president, Axis Bank: ?The reading is very very hawkish and what will happen is a front -loading of further tightening of policy in 2011-12. However, given the nature of the price shocks, the effectiveness of these measures in containing inflation remains uncertain.? Bankers believe that loan rates may not trend up just yet. MD Mallya, CMD, Bank of Baroda, pointed out that with just about a fortnight to go before the end of the busy season, the demand for credit could moderate. However, Mallya observed that ?while the base rates and the benchmark prime lending rates may not be upped, there could be some realignment of loan rates through the adjustment of spreads.?
Almost all banks have increased their base rates by about 50 basis points in the last couple of months. On the liabilities front, bankers contend that rates could topping out with banks offering around 9% for one year money and so, deposit rates are unlikely to move up.
Earlier this month, China upped its benchmark one-year lending rate to 6.06%, the third increase since mid-October after growth accelerated and inflation stayed above 4% for a third month.
With crude oil prices rising nearly 20% in the last three weeks in the wake of the Middle East unrest, South Korea, Thailand and Vietnam have all upped borrowing costs this month.