IHS Global Insight Perspective | |
Significance | India's central bank, the Reserve Bank of India (RBI), raised its key policy repo and reverse repo rates by 25 basis points, to 5.0% and 3.75%, respectively, and the cash reserve ratio by 25 basis points, to 6.0%, and it indicated further tightening in the months ahead. |
Implications | Monetary tightening had already begun gradually, and the RBI continued its path of steady tightening begun in October 2009 with the latest increases in policy rates and the cash reserve ratio. The latest rate hikes come as inflation continues to threaten from both the supply side and demand side. |
Outlook | The rate hikes and the efforts to mop up excess liquidity continue the expected normalisation process as the RBI unwinds in earnest its earlier accommodative stance implemented during the global recession. IHS Global Insight expects the RBI to tighten policy systematically throughout 2010 and 2011 in line with robust growth. We expect an additional 100 basis points of policy rate hikes by end 2010, with at least 25 basis points coming before the next monetary meeting in July. |
Rate Hikes Continue
In statements accompanying its policy decision today, the Reserve Bank of India (RBI) maintained its hawkish tone. The RBI increased both its key policy repo and reverse repo rates by 25 basis points, to 5.25% and 3.75%, respectively, continuing its process of bringing policy rates back to neutral following the end of the global recession. The 25-basis-point cash reserve ratio (CRR) hike brings the rate to 6.0%, and followed January's 75-basis-point CRR hike. Today's CRR hike will absorb about 125 billion rupees, or US$3 billion of excess liquidity from the financial system.
During the aggressive monetary easing campaign during the global financial crisis of 2008/09, the RBI had lowered the CRR by a cumulative 400 basis points, the repo rate by a cumulative 425 basis points, and the reverse repo by 275 basis points.
Now the RBI is in clear tightening mode. The repo and reverse repo rate hikes, coming just a month after the 25-basis-point March hikes, signal that the central bank is overtly concerned about inflation. The CRR was also raised aggressively, by 75 basis points, earlier, in January; and the RBI began reversing some of its special liquidity measures implemented during the crisis in October 2009.
Today's rate action was exactly in line with IHS Global Insight's expectations. Despite the inter-meeting rate hike in March, still-spiralling inflation pointed to all-but-certain rate hikes at today's monetary meeting.
Inflationary Pressures Persist
The RBI is justifiably concerned about the inflationary picture. Despite some recent moderation, food prices remain near decade-high levels as the delayed effects of the 2009 drought seep through. According to data released last week, food prices within the wholesale price index (WPI) rose by a steep 16.7% year-on-year (y/y) in March. Also during March, fuel prices increased 12.7% and manufactured goods' prices increased 7.1%, showing that inflation is now spilling over into other segments. The overall WPI marginally edged upward; it increased 9.90% y/y in March, up slightly from February's 9.89% rise.
Robust domestic demand is also keeping inflation elevated. Consumer price index (CPI) inflation stood at 14.9% y/y in February, reflecting still-high prices for both food and non-food goods. As inflation remains high, long-term 10-year bond yields are rising as buyers fret about government borrowing, higher inflation and higher policy rates.
The RBI pointed out both demand and supply-side causes of high inflation. It noted higher food and global commodity prices, pricing power returning to Indian corporations, and pressure on prices from higher excise and customs duties. The RBI emphasised uncertainties on the inflationary front, pointing to persistent effects of the drought on food prices, volatile oil prices and increasing demand-side pressures.
Outlook and Implications
The central bank's outlook for economic growth is upbeat, and it predicts that inflation will gradually ease from its current double-digit levels, and predicted a March 2011 WPI inflation forecast of 5.5%. We also believe that WPI inflation might be sticky, with India's robust domestic activity exerting pressures from the demand side.
Today's monetary action indicates that the RBI prefers to adopt a more gradual and cautious approach to rate hikes, choosing not to raise policy rates by 50 basis points despite stubbornly high inflation. The last rate hike occurred exactly one month ago. It is likely that the RBI was hesitant to alarm markets with a very aggressive 50-basis-point hike.
But keeping inflation in check will require sustained monetary tightening by the central bank over the next few months. The RBI itself said outright today that its "top priority" was to "anchor inflationary expectations" while responding "swiftly and effectively" to any further build-up of inflationary pressures.
The rate hikes and the efforts to mop up excess liquidity continue the expected normalisation process as the RBI unwinds in earnest its 2008/09 policy. IHS Global Insight expects the RBI to tighten policy systematically throughout 2010 and 2011 in line with robust growth. The RBI will steadily tighten the cash reserve ratio in the near term. We expect an additional 100 basis points of policy rate hikes by end-2010, with at least 25 basis points coming before the next monetary meeting in July, and also steady tightening of the cash reserve ratio in the near term.