RBI likely to raise key rates by 125 bps

Written by Shobhana Subramanian | Shobhana Subramanian | Updated: Jun 30 2010, 04:39am hrs
With inflation expected to stay in double digits during June and July, thanks to the hike in fuel prices, the debate on how soon the central bank will raise key policy rates has been revived. Economists expect that the impact of the hike in fuel prices would be around 120 basis points and that inflation will hover around the 10.75-11% mark, translating into an average, for the year, of around 9%. That means, that real interest rates will continue to be negative, hurting small savers. Its not surprising at all, the banks arent able to mop up deposits at the pact which they were doing so earlier. The government, of course, is able to borrow cheap as are the more creditworthy companies.

While the consensus some time back was that the central bank will up key policy rates by about 75 basis points between now and March 2011, the increase could be slightly higher between 100 and 125 basis points. Its unlikely to make money more expensive than that given that its counterparts in the developed markets arent able to touch their rates. The US Federal Reserve left rates unchanged at its last meeting and indicated rates would remain at these low levels for sometime. Indeed, whereas it was expected that some central banks in the western world may start increasing rates by the year-end, it may not happen till next year. The latest numbers from the US, relating to job data, were disappointing indicating that the pace of recovery could be slower.

However, given that inflation is a serious problem in the Indian context, the central bank has little choice but to send out the right signals. A 50 basis points increase in key policy rates, at the next monetary policy meeting on July 27 is now almost a certainty. In fact, should liquidity ease, its possible, that part of the hike, of 25 basis points, may happen even earlier, given theres almost a month to go. The bond markets were a tad nervous last Friday with the yield on the 10-year benchmark closing at 7.65%.

The equity markets, however, are celebrating the governments commitment to reforms in the oil and gas sector and the improvement in its balance sheet and those of the oil marketing companies. At the same time, the Street remains mindful of the fact that government could well intervene if crude oil prices shoot up significantly. The markets would also do well to keep in mind that inflation, which for consumers, will be way above what the indices reflect, could hurt spending on certain items since the food basket will most certainly become more expensive. As for companies, higher fuel prices will hurt them too, whether directly or indirectly. So while earnings of OMCs will get a boost, profits for users could be somewhat impacted. With the economy on a roll, higher interest rates should not hurt corporate borrowers too much. Theres enough moving into India from around the world and enough of an appetite for Indian paper, both debt and equity and, so far, money hasnt been in short supply. But with valuations now increasingly expensive, money, it appears, will be available only to those who price their shares appropriately.