Vibrant growth likely to tempt central bank to up rates again

Reviving growth was a priority just a year ago but India?s quick return to high economic growth path this year is likely to tempt the hawkish central bank to hike interest rates again on September 16 to curb demand and inflation.

Reserve Bank of India governor D Subbarao may have to take a hard look at growth prospects of coming quarters to see if the trend of growth is consistent with high inflation. Subbarao has already hinted that a little bit of growth could be sacrificed to tame inflation, which clearly means the balancing act is tilted towards inflation management.

The stellar 8.8% economic growth in April-June has all the more drummed up a debate within government and economists? circles that economy was showing early signs of overheating and the mercury level would only rise in later half of 2010-11 (April-March).

Although policymakers and analysts expect growth to moderate in July-September, it will mainly be due to a statistical aberration and not due to lower demand. Finance ministry?s chief economic advisor Kaushik Basu said economic growth in October-December will bounce back to over 9% after dipping below 8.8% in July-September as benefits of robust summer crop and revival of services exports show up later.

After looking into the GDP growth data, Planning Commission deputy chairman Montek Singh Ahluwalia recommended RBI should not ?loosen? its policy stance just because GDP growth was set to moderate a bit in the coming quarter.

As RBI works its policies based on its assessment of future expectations of both growth and inflation, analysts expect another small 25 basis points hike in policy interest rates on September 16. ?Theoretically, when inflation surges, growth is moderated. Situation is different now as we see both growth and inflation rising,? said NR Bhanumurthy, an economist at National Institute of Public Finance and Policy.

?So RBI will raise rates by 25 bps as inflation expectation is still there,? he said. Nomura economists Sonal Varma and Ketaki Sharma said in a research report they expect 25 bps hike in repo rate and 50 bps hike in reverse repo on September 16, and a pause in the following policy review scheduled on November 2.

If not on September 16, some analysts bet the rate hike would come in November quarterly review. ?Growth will soften in July-September. Inflation is also expected to come down. Monetary tightening will continue but at a gradual pace. There will be nothing on September 16,? said DK Joshi, principal economist, Crisil.

Government officials have mixed opinion over the current economic situation. ?We have to see whether there is any overheating,? Planning Commission deputy chairman Montek Singh Ahluwalia said ahead of the GDP data. However, plan panel?s principal advisor and former chief statistician Pronab Sen said he did not see any evidence of overheating until now.

Private analysts point out that present high growth is domestic demand driven as exports still show a decline in rupee terms and the benefits of a good summer crop will show up in October-December. ?Our feeling is that the Indian economy can?t grow over 7.8% in 2010-11. Going by April-June GDP numbers, there are some signs of overheating,? said NIPFP?s Bhanumurthy.

?Historically, April-June growth is always high compared with July-September quarter. Yet, the 8.8% growth in April-June is on the higher side,? he said. Yes Bank chief economist Shubhada Rao said the term ?overheating? was too strong a word to describe current state of Indian economy.