Moderate rate hikes to continue, harsh policy measures unlikely

Reserve Bank of India will continue the policy of moderate rate hikes at its September 16 mid-quarter policy review on robust economic growth and expectation of bumper kharif crop this year.

It may not take a hawkish monetary stance to combat inflation or thwart any possible overheating in the economy.

This is because RBI governor D Subbarao is unlikely to have forgotten the lesson learnt from the central bank?s tough monetary stance under similar circumstances in the mid-1990s.

Surging inflation back then led to the central bank turning strongly hawkish, tightening its monetary stance to cool any overheating in the economy.

The impact was felt for years ?liquidity in the system contracted and inflation cooled ? but economic and industrial growth turned anaemic, with sluggishness lingering until 2002-03. This is perhaps why analysts are unanimous that harsh monetary stance is unlikely, but most underlined that moderate rate hike is likely.

Positive signs

Usually, strong gross domestic product growth and robust farm output estimates give the central bank cues to up rates.

The country?s GDP grew a robust 8.8% in April-June. There are also expectations of bumper harvest of kharif crop.

Kharif crops such as paddy, lentils, coarse cereals and oilseeds will enter the market from late September or early October, increasing supply of farm products and cooling annual food inflation, which was an uncomfortable 10.9% in the week to August 21.

?We can expect bumper kharif output,? Sudha Pillai, member secretary, Planning Commission, said. Prices of arhar, urad and moong have already started declining on expectations of good output.

Little surprise then that Planning Commission deputy chairman Montek Singh Ahluwalia is confident food inflation will decline by October end.

Food prices will also cool as government last week released additional 2.5 mt rice and wheat to states for distributing to the country?s poor at subsidised rates.

Moderation is key

Analysts see the central bank?s governor sticking to moderation by tightening money in small doses or ?baby steps? ? like he has been doing since February.

In a poll, most economists said RBI will raise both repo and reverse repo rates by 25 bps on September 16. A significant minority said the rates won?t be changed on September 16.

It is unlikely to raise CRR, said A Prasanna, an economist at ICICI Securities Primary Dealership, mainly because even though liquidity is somewhat easy now, it will tighten when companies make tax payments. ?A tough stance is unlikely as liquidity will tighten after companies pay their advance taxes by mid-September,? said Prasanna. He noted RBI will not want to exacerbate liquidity tightness by upping interest rates sharply.