Reuters | Tue Apr 20, 2010 | 3:04pm IST
The Reserve Bank of India (RBI) on Tuesday raised key interest rates by 25 basis points, as expected, to battle near double-digit inflation, signaling gradual tightening ahead to sustain growth and manage record government borrowing. The Reserve Bank of India’s measured steps, which included raising the cash reserve ratio (CRR) requirement for banks by 25 basis points, increased the likelihood of another rate rise before its next quarterly review in July, some watchers said. The yield on the 10-year benchmark bond traded at 8.01 percent, down 7 basis points on the day, after easing to 7.98 percent after the RBI announcement, its lowest since April 13, as some players had bet on a bigger 50 basis point rise. The main 30-share BSE index was up 0.4 percent.
"The policy statement is not hawkish enough to address the concerns on the inflation front," said Rupa Rege Nitsure, chief economist at the Bank of Baroda in Mumbai. Price pressures are spreading beyond food to costs of fuel and manufactured goods such as cars. March inflation reached 9.9 percent year-on-year, its fastest pace in 17 months. However, the RBI is under pressure from the government not to raise rates aggressively, with New Delhi worried it could dent economic growth and also complicate its borrowing, which will reach a record $100 billion in the current fiscal year. "RBI at this juncture is more constrained by the management of the government’s record borrowing programme," Nitsure said.
The RBI is expected to raise rates by a further 100 basis points over the next 12 months, according to the one-year overnight indexed swap (OIS) rate at 4.95 percent. That is in line with a Reuters poll ahead of Tuesday’s review, which forecast 100 basis points of tightening by the end of 2010. "The next scheduled
meeting is now around three months away, but if incoming inflation data over the interim period show price pressures continuing to build, there is a good chance that the RBI will deliver another off-schedule rate hike," said Brian Jackson, an economist with Royal Bank of Canada in Hong Kong. Tuesday’s rise follows a quarter-point hike in mid-March when India became the second Group of 20 country after Australia to lift interest rates as the global economy recovers from its worst downturn in generations. "With the recovery now firmly in place, we need to move in a calibrated manner in the direction of normalising our policy instruments," RBI Governor Duvvuri Subbarao said in a statement.
Some economists said that while the RBI’s expectation for 8 percent growth in the current fiscal year is realistic, its prediction that inflation will come off current highs to 5.5 percent by the end of March 2011 is optimistic. Only China is growing faster among major economies. Finance Minister Pranab Mukherjee on Tuesday was bullish about the outlook for growth and said inflation had already peaked and was on its way down, a hint for the RBI that it did not need to tighten aggressively. A gradual rise in policy rates would please the government, which has traditionally been more concerned with keeping up fast growth than clamping down on inflation despite rising protests over high food prices.
"India has now bounced back, with growth seemingly back on track and inflation, though high, on a clear downward trend. Hence, I believe that it is time to move back towards ‘neutral’ policy rates, that is, rates that should prevail when an economy is stable and on track," Mukherjee said, predicting fiscal year-end inflation closer to 4 percent. The RBI lifted the reverse repo rate, at which it absorbs excess cash from the banking system to 3.75 percent and raised the repo rate, at which it lends to banks, to 5.25 percent. The rise in the cash reserve requirement to 6.0 percent, effective from April 24, which will drain 125 billion rupees ($2.8 billion) from the system, was also in line with forecasts.
EYES ON THE SKIES
A successful summer monsoon would help ease the pressure from high food prices following last year’s drought, although it might also add to demand-driven inflation. A move towards market-based fuel prices, which the government has put on hold amid opposition attacks over rising prices, would also add to headline inflation. Subbarao said inflation is becoming increasingly generalised, with evidence that pricing power for companies has returned. "With the growth expected to accelerate further in the next year, capacity constraints will re-emerge, which are expected to exert further pressure on prices," he said, adding that inflation expectations remained high. Robert Prior-Wandesforde, senior Asian economist at HSBC in Singapore, said the RBI may still be cautious about the durability of recovery and the outlook for consumer spending. "The Bank may also have one eye on the government’s front-loaded borrowing programme, which the policy authorities will obviously be hoping to get away at the lowest possible cost," he wrote in a note. Bond yields shot higher this month on worries over inflation and government borrowing, with the yield on the 10-year bond rising to an 18-½ month high of 8.13 percent last Thursday.