September review could see another 25-50 bps increase in rate

Written by Shubhada Rao | Shubhada Rao | Updated: Jun 17 2011, 06:57am hrs
After a brief display of aggression in May, the Reserve Bank of India has reverted to its measured approach to rate tightening. The global macro economic conditions since then have deteriorated while domestic factors impinging on inflation have remained broadly intact.

Inflation expectations yet remaining elevated bear testimony to the fact that past ten rate hikes have had a limited impact on reining in inflationary pressures in the economy.

This has been the context setting for the 25 basis points hike in the mid-quarter review of RBIs monetary policy.

The tone of the accompanying statement has stopped short of sounding ultra hawkish on account of two factors: adverse global economic developments witnessed in recent weeks and the growth and inflation trajectories moving along expected lines as outlined in the Annual Monetary Policy Statement

of May 3.

Does this signal that we are close to peaking in the interest rate cycle The simple answer at this point in time is No as there still remain sufficient incremental pressures on inflation on account of incomplete pass through of high international crude oil prices, rising wages and input costs.

On the growth front, no sharp or broad based deceleration is yet in evidence.

Steady profit growth and margins, credit growth and non-oil imports suggest that economic activity is holding course. This implies that there is still room for more rate hikes.

With monetary policy transmission having emerged more efficient, the impact of past monetary policy actions is still unfolding, which is expected to moderate economic activity in the coming quarters.

Furthermore, while slowdown in global growth may lower upside risks to inflation by restraining commodity prices, it would also exert a dampening impact on domestic growth through the export channel. Clearly some downside risks to growth are now emerging. In the coming months, the policy will be at crossroads when economic activity moderates at a faster clip with inflation remaining at elevated levels.

The growth versus inflation dilemma is evident in the following RBIs statement, While the Reserve Bankneeds to continue with its anti-inflationary stance, the extent of policy action needs to balance the adverse movements in inflation with recent global developments and their likely impact on the domestic growth trajectory.

To manage the current dominant inflation drivers, we believe that fiscal and administrative measures are better equipped. However, the inherently slow process of supply side adjustments leave limited options but to lean heavily on monetary tools to prevent firm entrenchment of inflation expectations. Against these pulls and pressures we expect the Reserve Bank of India to deliver another 25-50 basis points by September.

The author is chief economist,

Yes Bank. Views expressed are personal