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."
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What govt. needs to do is to remove the supply side constraints for longterm cooling of inflation. This would happen only if production & supply is incentivized and hurdles & bottlenecks removed.
For our evergrowing nation of 1.2 billion people with inclusive development and benefit of expanding economy percolating to the grass root levels, which is essential and 100% welcome and must be encouraged rather than checked, a different approach is called for.
Blanket increase in interest rates affect all sectors- priority as well as others, from agriculture, housing, micro & small, exports to the largest of corporates. Govt. should rather look at different sectors on the basis of their growth rate and priority assessment. For example, it's time to withdraw economic stimulus of concessional excise duty of 10% against the normal 14% to sectors like white goods, particularly A.Cs & other luxury segments like toiletries, cosmetics, high-end fittings, music systems, large TV screens etc. to luxury segment automobiles, specially the diesel driven cars & SUVs.
I believe that priority sectors & BPL need to be protected from blanket interest rate hikes. Inflation be checked though demand cut in non-priority and luxury segments, Excise Duty normalisation in these areas be looked into, supply side be incentivised by protecting capacity building through CAPEX and or invest allowance route, Diesel cars & SUVs pay higher Excise Duties to offset diesel subsidies, other measures to check inflation while protecting the priority and weaker sections be introduced.
Otherwise, all we'll get in another quarter may be the 12th increase in interest rates, and a different category of poverty virus striking the middle-class and Micro & Small Enterprises.