In its mid-quarter monetary policy review of March 17, the Reserve Bank of India (RBI) raised both the repo and the reverse repo rate by 25 basis points (bps) each. The repo rate has now climbed to 6.75 per cent while the reverse repo rate stands at 5.75 per cent. This was the seventh time that the RBI raised policy rates in FY11. It revised its inflation forecast for March 2011 by one percentage point to 8 per cent. RBI also indicated that it would continue with its anti-inflationary stance in the near future.
Inflation the Key Worry
The rate hikes were expected after WPI inflation for February crept up to 8.3 per cent (compared to 8.23 per cent in January). Moreover, the December inflation figure got revised upward to 9.4 per cent from the previously reported 8.4 per cent. The average inflation for FY11 is now a daunting 9.2 per cent.
Food prices are no longer the key drivers of inflation: food inflation has declined from 17 per cent in December to 9.5 per cent in February owing to the coming of the new rabi crop into the market. Inflation is now being driven by high international prices of oil and other commodities.
Another cause for worry is the rise in core (non-food manufactured goods) inflation that has gone up from 5-5.5 per cent between June and October 2010 to 6.1 per cent in February 2011. This signals the second-round impact of rising input costs. This is of particular concern to the central bank which wants to manage inflationary expectations and contain the spillover of food and commodity prices into more generalised inflation.
According to a note from Crisil Research, WPI inflation is expected to average 9 per cent in FY11 and 5.8-6 per cent in FY12. However, it adds that the recent escalation in crude oil prices due to tensions in the MENA region have increased upside risks.
In its last monetary policy review, RBI had mentioned that inflationary pressures could moderate in the first half of FY12. This time there was no mention of moderation. Says Abheek Barua, chief economist, HDFC Bank: “Not only is the rate hiking cycle in FY12 likely to be more extended than earlier anticipated, it is also likely to be more front-loaded.” Barua expects the central bank to raise key rates by 25 bps in its annual review in May, and by 50-75 bps in FY12.
Growth Slowing Down
According to Crisil Research, the recent moderation in industrial output can be attributed to the high base effect of last year. The IIP index continues to show an uptick on a month-on-month seasonally-adjusted basis. On an year-on-year basis, industrial growth fell to a low of 2.5 per cent in December 2010, before recovering to 3.7 per cent in the next month. Capital goods growth remained volatile: it turned negative in December-January 2010-11 after having registered double-digit growth in the preceding two months, suggesting a slowdown in investment momentum.
GDP growth has moderated from 8.9 per cent in Q2FY11 to 8.3 per cent in Q3FY11. Crisil expects GDP growth for FY12 to slow down to 8.3 per cent, slightly lower than the Central statistical Organisation’s (CSO) advance estimates of 8.6 per cent.
Barua points out that in the growth-inflation trade-off, the Reserve Bank is likely to be more concerned about inflation hereafter. Besides the weakening of the investment cycle, growth in non-oil imports has also declined from 34 per cent in the first half of FY11 to 10 per cent between October and January. Owing to the growing risk to growth, Barua says: “We hope that in future monetary measures will be taken in a phased and calibrated manner.”
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