Reuters | Thu Jul 29, 2010 | 1:42pm IST
A Reserve Bank of India official said current policy rates will not tame inflation and aggressive action is needed, two days after it raised rates more sharply than expected and adopted a hawkish tone. Bond yields and swap rates rose following the remarks, which were unusually forceful for a Reserve Bank official. Also on Thursday, India reported that food inflation eased in mid-July but fuel inflation rose slightly. "You are injecting liquidity at 5 percent and inflation is at 10 percent. They will never be able to control inflation, everything else remaining the same," the official told reporters, declining to be identified. "Monetary policy has to be aggressive," the official said. Wholesale price index (WPI) inflation is on track to hit 11 percent in July, which would make it six straight months in double digits, and many economists have said the Reserve Bank of India (RBI) is behind the curve in taming inflation despite four interest rate increases since March.
"Monetary policy works with a time lag," the RBI official said, adding that the summer monsoon rains will have more impact in curbing inflation over the next 2-3 months due to the time-lag in monetary transmission. Last summer’s poor monsoon sent food prices higher, but inflation has spread generally into the economy. This summer’s monsoon is normal, which officials are counting on to improve harvests and take pressure off prices. "Rates should have come up much higher (by now)," the official told reporters after a meeting with senior finance ministry officials. "RBI is not the real monetary policy maker," the official said, hinting that the finance ministry has a large role to play in monetary policy decisions. Most economists polled by Reuters following the RBI’s policy tightening on Tuesday expect it to lift rates again by the end of September, implying they expect the central bank to take advantage of its newly announced plan to double the frequency of policy reviews to eight times a year.
"Post the central bank official’s comments, interpolicy rate hike fears are back — notwithstanding the fact the next policy is just six weeks away and some key data like IIP is still pending. Markets are living on the edge," said R. K. Gurumurthy, head of treasury at ING Vysya Bank. India’s benchmark 10-year bond yield rose as much as 5 basis points (bps) to 7.79 percent after the central official’s comments. The one-year swap rate was up 7 bps at 6.20 percent, from 6.13 percent before the statements, revisiting a near-21 month high of 6.20 percent touched on Wednesday, according to Thomson Reuters data.
MORE TIGHTENING AHEAD
On Tuesday, the RBI raised the repo rate, at which it lends to banks, by 25 bps to 5.75 percent, matching forecasts. But it bumped up the reverse repo rate, used to absorb excess cash, by 50 bps to 4.50 percent — twice as much as markets had expected. Most economists in the Reuters poll had expected the repo rate to reach 6.5 percent by the end of the fiscal year in March, with the reverse repo rate reaching 5.25 percent in the same period. With the RBI lifting its headline inflation projections for the year to end-March to 6 percent, economists now expect more aggressive tightening than earlier foreseen. Data released on Thursday showed the food price index rose an annual 9.67 percent in the week to July 17, compared with the previous week’s increase of 12.47 percent, with prices of cereals, rice and vegetables falling on the week. The fuel price index rose 14.29 percent in the period, as against a 14.27 percent in the previous week. The government raised prices of fuels in late June. The primary articles index rose 14.50 percent compared with the week-ago reading of 16.48 percent. Wholesale price inflation, the most widely watched measure of prices, was at 10.55 percent in June.
Various government arms have different inflation forecasts, ranging from Prime Minister Manmohan Singh’s prediction of 6 percent by December to the 7 percent to 8 percent projected for the period by his economic advisers. They also differ on their reading of the causes of inflation. The government blames high food prices and says a good monsoon will cool prices, while the RBI says demand-side effects would keep inflationary pressures intact. High prices are a political headache in a country where hundreds of millions live on less than $1.25 a day. Massive street protests have been mirrored in parliament, where the opposition parties have stalled proceedings demanding a vote against the Congress-led government for failing to control inflation.