Will Reserve Bak of India Guv Raghuram Rajan maintain hawkish stance

Written by ENS Economic Bureau | Updated: Nov 18 2013, 19:14pm hrs
Raghuram RajanRBI Governor Raghuram Rajan says no single data point or number will determine the central bank's next move on the interest rate front.
Reserve Bank of India (RBI) Governor Raghuram Rajan says that no single data point or number will determine the cbanks next move on the interest rate front.

The weak state of the economy, as well as the good Kharif and Rabi harvest, will generate disinflationary forces that will help, he says, and we await data to see how these forces are playing out.

In fact, persistence of inflationary pressures coupled with weak growth has complicated the policy decisions for the RBI. The biggest question buffeting the banking sector is: will the RBI keep on raising rates in its strategy to bring down inflation While many economists forecast a hike in repo rate in the next RBI policy review, opinion is unanimous that the RBI will continue its hawkish stance.

According to Leif Eskesen, Chief Economist for India and ASEAN, HSBC, lingering inflation risks, notwithstanding the soft growth backdrop, should keep the Reserve Bank singing a hawkish tune.

While the recent rise in inflation may have been a catalyst to hike repo rates, an equally important reason is an implicit change in the RBIs monetary policy framework, away from WPI inflation towards CPI inflation.

This framework suggests that because of current high CPI inflation, the present repo rate has been persistently below the neutral rate, so recent repo rate hikes are intended to align interest rates to real domestic inflationary conditions. With CPI inflation close to 9.5 per cent and deposit rates in an 8-9 per cent range, a positive real return to savers still calls for a further hike in the repo rate, said Sonal Varma, economist, Nomura.

While the repo is likely to be made the operative rate eventually, the process of full normalisation of monetary policy appears to be a multi-month process.

Said Indranil Sen Gupta and Abhishek Gupta, India economists, Bank of America Meriill Lynch, We grow more confident that the money market will switch to repo mode from MSF by late November as the Diwali cash demand works itself out. The RBI will likely seal this shift with a 25 bps final repo rate hike on December 18.

Moves (on October 29) to support cash provided to banks through term repo to 0.5 per cent of bank deposits from 0.25 per cent previously should increase both the availability and lower the incremental cost of funds in the interbank markets.

These will be the guiding principles shaping the terminal policy rate outlook, which we expect to be reached in early 2014 that terminal policy setting will be a repurchase rate of 8 per cent and the gradual adoption of the repurchase rate as the operative rate, said Glenn Maguire, Chief Economist, Asia-Pacific, ANZ.

Upasna Bhardwaj, Chief Economist, ING Vysya Bank, said, We expect the RBIs decision going ahead to remain a function of the underlying trends in both growth and inflation. While a 25 bps of rate hike cannot be ruled out, the next few data releases of GDP, inflation and other economic activity indicators will be crucial in deciding the policy action and the timing. Also, the external environment and its consequences on the rupee will be the key driver. We do not expect a rate hike in December.

The RBI Governor has indicated that dollar demand from oil companies will be gradually tapered keeping in mind the value of the rupee, a credible fiscal consolidation plan and growth prospects. Hence, while the repo is likely to be made the operative rate eventually, the process of full normalisation of monetary policy appears to be a multi-month process.

US firm Goldman Sachs expects inflation to remain elevated in the near-term due to pass-through of rupee depreciation into the prices of manufactured products, along with elevated food and fuel inflation.

The RBIs bias appears to be towards combating inflation and moving towards positive real rates (with respect to CPI), but at a measured pace given a desire to monitor food prices, Goldman Sachs says in a report.

October headline inflation came in broadly in line with market expectations at 7 per cent as compared to 6.46 per cent in the previous month.

However, a bigger shock was the sharp upward revision in the final estimates of August WPI inflation to 6.99 per cent from earlier estimate of 6.1 per cent.

US Federal Reserve tapering of monetary stimulus will also have an impact on the the RBIs actions.

Although the RBI actions and recent macro improvements probably reduce the sensitivity to Fed tapering, the market will likely be challenged when the US Fed does decide to act, which we currently expect in March 2014, Goldman Sachs says.

Power point

* According to Leif Eskesen, Chief Economist for India and ASEAN, HSBC, lingering inflation risks, notwithstanding the soft growth backdrop, should keep the RBI singing a hawkish tune

* Indranil Sen Gupta and Abhishek Gupta says, India economists, Bank of America Meriill Lynch, says the RBI will likely seal this shift with a 25 bps final repo rate hike on December 18

* Upasna Bhardwaj, Chief Economist, ING Vysya Bank, does not rule out a 25 bps rate hike

* Goldman Sachs expects inflation to remain elevated in the near-term due to pass-through of rupee depreciation

* US Federal Reserve tapering of monetary stimulus will also have an impact on the the RBIs actions