Bonds and equities rallied on Tuesday as the Reserve Bank of India (RBI) signalled a pause in the monetary tightening cycle, raising the key repo rate by 25 basis points to 8.5%. Investors, however, may have little to cheer since the central bank finally acknowledged that the economy is slowing down, with governor Duvvuri Subbarao expectedly paring the GDP growth projection for 2011-12 to 7.6% from the earlier 8%.
Moreover, given the excessive government borrowings, the bond market joy could be short-lived. The signalling of the pause, which comes after 13 hikes, has been prompted by the RBI?s confidence that inflation will taper off, partly due to the base effect as also due to the combined impact of lower prices of commodities and the cumulative impact of monetary tightening.
As such, it has left the inflation forecast of 7% in March 2012 unchanged. The seasonally-adjusted inflation data, the RBI said, has signalled a downtrend in the inflation momentum with an approximate 3% drop between the June and September quarters. Headline inflation has averaged 9.65% so far this year.
Explaining the rationale for a probable pause, Subbarao observed that ?notwithstanding current rates of inflation persisting till November, the likelihood of a rate action in the December mid-quarter review is relatively low. Beyond that, if the inflation trajectory conforms to projections, further rate hikes may not be warranted.? According to the central bank?s assessment, inflation will begin falling in December 2011 and then continue down a steady path to 7% by March 2012. As such, moderating inflation rates were likely to impact expectations favourably, leaving room for monetary policy to address growth risks in the short run.
Expressing concerns about growth, the governor said the Indian economy is clearly seeing slowing growth, in part due to the anti-inflationary stance of monetary policy that was a necessary precondition to bring inflation down. However, he pointed out that ?of larger concern is the fact that even with the visible moderation in growth, inflation has persisted?. The governor observed that although the slowdown might not be broad-based, there was a need to be sensitive to it.
While governor Subbarao expects monetary transmission, banks, it would appear, are not too keen to hike loan rates just yet, given that credit growth has been just about satisfactory, the market is competitive and liquidity adequate.
State Bank of India chairman Pratip Chaudhuri said at a press conference that there may be no immediate compulsion for banks to up loan rates while others pointed out that the corporate sector was already under pressure because of the high cost of money.
The growth in non-food credit has eased to 19.3% year-on-year in October from 22.6% in April. Subbarao said it was up to the banks to pick up RBI?s signals. ?We leave it to the banks to decide. There has been transmission in the past, though there may not have been a one-to-one correlation,? he said. Yes Bank upped the base rate by 25 basis points to 10.5% late on Tuesday.
Rohini Malkani, chief economist, Citigroup, said: ?The RBI has raised rates 13 times so far, effectively tightening policy by 525 bps. During this time, while the WPI has remained elevated at 9%-plus level, GDP growth has come off from 9% to 7.7%. While the RBI has said that the likelihood of rate action in December is relatively low, if the expected deceleration in inflation does not play out, risks on further monetary action coupled with deteriorating global prospects and domestic policy issues adds downside risks to our 2011-12 GDP estimate of 7.6%. This is reminiscent of 2008, when the RBI was possibly the last central bank to keep hiking rates.?
The deregulation of the interest rate on savings accounts, the governor observed , was aimed at giving customers a better return and partly to allow better transmission. ?We have deliberately not put a floor or a ceiling since we want banks to compete,? Subbarao observed.