Reserve Bank of India continues with monetary tightening despite slowdown
The Reserve Bank of India (RBI) today hiked short-term rates by 25 basis points (bps), persisting with its anti-inflationary monetary tightening measures.
The RBI announced it was hiking the repo rate (the rate at which it lends to banks) to 8.25% and the reverse repo rate to 7.25%.
This is the 12th time that the central bank has hiked key rates in 18 months, although it was widely expected that it may take a pause in the context of the economic slowdown.
The news of the rate hike dragged the stock market down more than one per cent. The benchmark indices, which were mostly positive this morning, dipped to just below Thursday’s closing levels, but recovered in volatile trading.
The Nifty which opened this morning at 5,123, nearly 50 points up from yesterday, slipped just after noon to 5,068, just under its previous close, then climbed back up about 0.7%. It was a similarly trend with the Sensex.
The central bank is still worried about high inflation, but with IIP tumbling to a 21-month low, a further slowdown in domestic demand and the turbulent global environment has increased the chances that the RBI might take a pause
The Reserve Bank of India (RBI) may not go in for another rate hike, or it may increase the rates by a minimal 25 basis points (bps), when it meets to review policy on Friday.
A majority of economists and brokerages believe that over the past several months, the central bank has focused on controlling inflation, albeit unsuccessfully, and with inflation still above the acceptable levels, the RBI could yet hike rates by 25 bps. However, there are others who feel that with inflation coming off sequentially, the slowdown in domestic demand and the turbulent global environment has increased the option value for the RBI to take a pause after increasing rates 11 times over the past 18 months.
"We expect the RBI's policy statement to remain hawkish-with a reference to inflation remaining the chief concern," says Tushar Poddar, economist, Goldman Sachs. The RBI's FY12 growth target of 8% and end-March 2012 inflation target of 7%, we think are likely to surprise on the downside. The RBI may, therefore, mention downside risks to its growth target, but may not explicitly lower it." He says that the bank will likely suggest that it is on a wait-and-watch mode, rather than explicitly signal the end of the tightening cycle.
Since March 2010, the central bank has been aggressive in its rate hikes, raising its effective policy rate to 8% from 3.25%. The pace of tightening accelerated in the summer, when the RBI tightened rates by 125 bps-raising it by 50 bps in May, 25 bps in June, and again by 50 bps in July. Both rate hikes of 50 bps were over market expectations.
Nomura Global Economics expects the RBI to hike rates by 25 bps due to elevated inflation pressure. "However, as signs of a moderation in growth are becoming more evident, implying weaker inflation pressures ahead, we believe it will be difficult for the RBI to maintain its anti-inflation bias for an extended period. We do not expect the RBI to hike rates again in this cycle after 16th September," the brokerage says.
Of course, there are enough reasons why the RBI could be tempted to hike rates yet again. Headline inflation, on a year-on-year (y-o-y) basis, has remained high and could potentially be aggravated by a big upside surprise in the August WPI inflation reading, scheduled to be announced on Wednesday. In addition, there is inertia in policy-making; while on the hiking cycle, the decision to take a pause would be a big one.
For the week ended 27th August, food inflation fell to 9.6% from double digits in the previous week, with prices of all items, barring pulses and wheat, going up on an annual basis. The decline could also be attributed to the high inflation rate of over 14% in the corresponding year-ago period, a phenomenon dubbed as the 'high base effect' in economic parlance.
The RBI and the Prime Minister's Economic Advisory Council (PMEAC) had projected headline inflation to remain high, at about 9% till October. In its economic outlook report for 2011-12 published in August, the PMEAC said that while pressure from food inflation had fallen in recent months, the rate of price rise remained quite high, with the possibility of a further surge in the coming months.
IDFC Securities feels that despite the concerns over slower growth, the rate hikes will continue. "With the three-month moving average of IIP falling to 6% y-o-y (the lowest in 19 months), concerns on the extent of growth moderation would be back to the fore. However, we believe it is unlikely to deter the RBI from its anti-inflationary stance. We expect RBI to continue with its rate hike cycle and expect another 25 bps hike in the monetary policy meeting in September 2011," the brokerage said in a report.
The July Index of Industrial Production (IIP) has been the lowest in 21 months. The 3.3% growth was significantly lower than the 8.8% recorded in June 2011. The sharp dip was caused by weak manufacturing and a steep decline in the capital goods sector. Year-to-date, IIP growth in FY12 stands at 5.8%, as against 9.7% in the corresponding period of FY11.
Sharekhan says, "IIP growth declined mainly due to a steep fall of 15.2% y-o-y in capital goods growth. The three-month moving average stands at 6%, showing broader signs of moderation in the industrial activity. We expect the IIP numbers to remain subdued for the next two to three months due to rising pressure on the manufacturing sector on account of the rising interest rates and input costs." It believes that the recent developments in the global environment and the strong deterioration in the domestic growth parameters have increased the probability of an early reversal in the RBI's monetary policy stance.
Domestic demand is weakening significantly with nearly every activity indicator showing a slowdown. Especially over the past two months, auto sales have seen negative growth y-o-y, while the manufacturing PMI is down to 52.6 in August from 55.3 in June.
Over the past four months, the RBI has been increasing rates quite aggressively. Between May to July this year alone, the central bank has increased rates by 125 basis points, 50 bps in May, 25 bps in June, and again by 50 bps in July. However, the effect of these rate hikes would reflect only in the second half of FY12 or post-September.
In this scenario, if the RBI decides to go for a hike once again, the impact would be felt only after two-three quarters, by which time inflation is likely to be significantly weaker according to the RBI's own forecasts.
Moreover, the global uncertainty and volatility in stock markets have already tightened financial conditions by more than what a 25bps or 50bps rate hike could probably achieve. This put together, gives the RBI ample reason to take a break from the rate-hike cycle.
Yes, the central bank appears to be still worried over high inflation, but with IIP tumbling to a 21-month low, a further slowdown in domestic demand and the turbulent global environment may have increased the chances that RBI governor Dr D Subbarao would press the pause button now.
Governor says there is need to persevere with anti-inflationary stance. Bond yields sharply up, while stocks drop
The Reserve Bank of India (RBI) today raised interest rates by a higher-than-expected 50 basis points, indicating the seriousness of the fight against high inflation, despite slowing growth.
The central bank said it was increasing the repo rate at which it lends to banks to 8% from the previous 7.5%, and the reverse repo rate, to 7% from 6.5%. This is more than the 25 basis points increase that the market was expecting. However, the cash reserve ratio (CRR) has been left unchanged at 6%.
The indices slid immediately after the announcement with the BSE Sensex down by over 300 points (or 1.5%) and the S&P CNX Nifty losing nearly 100 points (or about 1.7%).
This is the 11th rate increase by the RBI since March 2010, which is seen as the most aggressive among central banks in fighting inflation.
"RBI continues to maintain its hawkish stance towards inflation and only signs of sustainable downturn in inflation would result in change in RBI's stance, which indicates that pause in rate hikes is not in sight and will clearly depend on the inflation trajectory," opined Abhijit Majumder, senior research analyst-institutional equities, Prabhudas Lilladher.
The wholesale price index inflation was at 9.44% in June, more than double the RBI's comfort level, and the fear is that high prices could persist through the end of the year.
The RBI also revised upwards its outlook for wholesale inflation for the current year to March 2012 to 7% from the earlier 6%.
RBI governor D Subbarao said in his policy review statement, "Considering the overall growth and inflation scenario, there is a need to persevere with the anti-inflationary stance."
But the central bank stuck with its forecast for economic growth in the current year at around 8%, saying that while some interest-rate sensitive sectors have shown signs of moderating, "there is no evidence of a sharp or broad-based slowdown as yet".
"RBI's announcement of 50 basis points increase in repo rate comes as a major disappointment to the industry. With the growth momentum already under pressure, this move will further hurt the future prospects. Even the projected growth rate of 8% for the year 2011-12 now looks difficult to achieve" said Dr Rajiv Kumar, secretary general, FICCI.
Analysts widely expected the RBI to raise rates by about 25 basis points, while some believed there would be a pause in the tightening cycle due to signs of slowing growth and global uncertainty. Latest industrial output and manufacturing numbers were the worst in nine months and January-March quarter growth was a worse-than-expected 7.8%.
"The RBI's action to raise policy rate by 50 bps against market expectation of 25 bps in part reflects its desire to send a strong anti-inflationary message to market participants and in part reflects front loading of rate hikes. We expect another 25 bps rate hike and a pause thereafter to gauge the evolving growth-inflationary dynamic; however, policy easing is not on the cards yet. While, inflation will ease in the second half of the fiscal, in part due to base effect, full year inflation will average over 8%. While there have been signs of growth decelerating, we do not expect an abrupt deceleration in growth. We maintain our full year FY11-12 GDP growth estimate of 7.6%, down from 8.5% in FY10-11," Ashutosh Datar economist at IIFL said while commenting on the RBI's rate hike.
The RBI governor said today's measures are expected to "maintain the credibility of the commitment of monetary policy to controlling inflation". They will also "reinforce the point that in the absence of complementary policy responses on both demand and supply sides, stronger monetary policy actions are required."