More hikes likely

HITENDRA DAVE | Updated on January 25, 2011


A further series of hikes of at least 50 basis points in the medium term would be the minimum required to raise real interest to neutral territory.

The Reserve Bank of India has acted as expected and gone in for a 25-basis-point hike in both the repo and reverse repo rates, accompanied by a policy with hawkish undertones suggesting that the tightening cycle is far from over. Immediate reaction in the bond and swap markets suggest expectations of further action when the Monetary Policy Committee (MPC) meets again in March.

Rightly concerned

While the role of the monetary policy is rather limited in tackling inflation that has been triggered by commodity prices and structural constraints on the supply side, the RBI seems rightly concerned over spill-over effects on the demand side and a more generalised wage-led uptick in inflation. Interestingly, the RBI has also explicitly expressed a need to moderate non-food credit growth (24.4 per cent year-on-year) to more sustainable levels in the policy document.

There also seems to be an increasing concern on the widening current account deficit and the impact of global commodity prices on the deficit, inflation and fiscal parameters.

There is recognition that sustainable inflows (read foreign direct investment) are necessary to finance the current account deficit, especially in the face of a potential hardening of commodity prices with improving global growth prospects.

Key factor

To this extent, policy responses might err on the side of caution to protect interest in growth. Perhaps, this has been a key factor in the central bank deciding to go ahead with a more moderate hike of 25 basis points instead of shocking the market with a more aggressive move of 50 basis points.

We believe that the upward revision of the expected year-end inflation to 7 per cent and the overall tone of the Policy indicate a further series of hikes of at least 50 basis points in the medium term, which would also be the minimum required to raise real interest rates in the system to neutral territory.

Published on January 25, 2011

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