Monetary Policy: Rate hike cycle is close to peak

In its mid-quarter review of credit policy, the RBI has reiterated its policy stance in July.

Then, the Reserve Bank adopted a policy stance to maintain an interest rate environment that moderates inflation, anchors inflation expectations, and manages liquidity to ensure monetary transmission remains effective, without exerting undue stress on the financial system.

In the backdrop of a sharp decline in July factory output and a sharp rise in August inflation, both of which have been moving in opposite directions for over a year now, the Reserve Bank of India has decided to continue with its anti-inflationary stance.

The IIP numbers till July have been fluctuating, with 5.90 per cent, 8.80 per cent and 3.30 per cent for May, June and July 2011, respectively.

Hike discounted

The rate hike of 25 bps was largely expected and discounted in the market. However, the tone of the September review is less hawkish when compared with previous monetary policy statements, thereby indicating that the rate hike cycle is close to its peak.

Any further hike may not be warranted once agriculture and industrial production start picking up in the coming months.

The latest data shows that food inflation has declined marginally to 9.47 per cent for the week ended September 3. The fall in food inflation is attributed to a moderation in the rate of price rise of some of the items on a week-on-week basis, even though they remained higher on an annual basis.

Overall, inflation in primary articles stood at 13.04 per cent, down from 13.34 per cent in the previous week. Primary articles account for one-fifth of headline inflation.

Liquidity

As liquidity is not hugely negative, the 25 basis point increase in the repo rate may not have much influence on the short-term money market rates and deposit rate of the banks.

Banks may consider passing on the repo hike in their lending rates at least partially, mostly after end of the September 2011. Meanwhile, the yields on Government Securities may continue to be under pressure with 10-year yield capping at 8.40 per cent levels.

Subsequent to the last policy announcement in June global concerns have heightened substantially. US sovereign rating has been downgraded to AA+ from AAA after several decades. The US economy is facing the possible threat of double dip recession.

The prospect of sovereign default among some Euro members still looms large. Major banks are being downgraded. There is a large scale sell-off in global equities.

(The author is CMD, Indian Overseas Bank. The views are personal.)

COMMENT NOW