Asset prices to cool down

Written by Romesh Sobti | Updated: Oct 31 2007, 06:26am hrs
The RBI has chosen to respond to strong inflationary pressures. While headline inflation has eased over the past few months, the fact that consumer price inflation is holding well above 6% and commodity prices are rising indicate the overall inflation scenario is not all that benign. That said, headline WPI inflation is likely to remain within the RBI comfort rate of 5% this fiscal year, but the central bank now seems to be placing more stress on targeting inflation expectations than the actual rate.

Heavy intervention by the central bank in the currency market over last one month and faster pace of money supply growth had also necessitated a hike in the CRR. From the monetary policy perspective, CRR hikes have proved to be more efficient in the transmission of policy signals (in the form of higher rates in the economy). Moreover, with foreign exchange reserves growing at a brisk pace, the RBI now seems to be concerned about the rising costs of sterilisation of rupee liquidity. A CRR hike also helps to reduce these sterilisation costs for the central bank.

This CRR hike will reduce the banking system liquidity by about Rs 15,000 crore. Therefore, we should see some upward pressure on rates and the rupee. This monetary tightening will also help in cooling down asset prices to some extent, particularly equities.

On the growth front, while keeping the real GDP forecast for FY08 at 8.5%, the RBI has highlighted a number of risks. The central bank indicates that the impact of a stronger currency could extend outside the exports sector and affect overall real sector activity. A spiral in international oil and food prices also poses a threat to the robust growth conditions in the economy. Keeping these risks in mind, the central bank has chosen to be cautious on growth. Overall, the RBI has adopted a 'wait-and-watch' approach in the policy with a tightening bias. This is perhaps also keeping in mind that the US central bank, Federal Reserve, will ease monetary levers further. And, in such a scenario, the RBI will have to deal with another rush of capital inflows.

The author is EVP & country executive, India, ABN AMRO Bank