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According to the RBI, going forward, the inflation
outlook will be shaped on the basis of how the food price
situation, both domestic and global, evolves, how global
commodity prices behave and the extent to which
demand side pressures may manifest.
On its part, the RBI has raised the baseline projection of
WPI inflation for March ’11 from 5.5% to 7%, based on
several considerations. First, the upside risks to inflation
that the RBI had mentioned in the mid-quarter review of
December ’10, have materialized as reflected in the
increase in prices of metals and non-administered fuel.
Second, there have been some transitory supply shocks,
which triggered a sharp increase in vegetable prices.
Third, petroleum and aviation turbine fuel prices went up
in early January, which will add 9 bps to WPI inflation.
“While the impact of transitory factors is expected to
dissipate, price pressures on account of demand-supply
imbalances with respect to some commodities will
persist,” said Subbarao.
Regarding the domestic economy, the 8.9% GDP growth
in the first half of 2010-11 suggests that the economy is
operating close to its trend growth rate, powered mainly
by domestic factors. With the risks to growth in 2010-11
being on the upside, the baseline projection of real GDP
growth is retained at 8.5%, with an upside bias.
Therefore, technically the economy has been and may
continue to be in a high growth - high inflation scenario.
“Gradual increase in interest rates would perhaps be the
best approach to manage inflation without disrupting
growth,” said an economist.
Of late, the shift in policy priority has been fast. While
hiking both repo and reverse repo rates by 25 basis
points, the November policy review had almost explicitly
indicated the central bank’s preference for a pause in rate
action in the near term.
It was geared towards fine-tuning the exit, hinting more
at nuanced and directed policy measures in the subsequent
months like prudential norms, including provisioning
requirements, risk weights for banks’ exposure
towards sectors like real estate.
The RBI’s December mid-quarter policy action was
centered on tackling the excessive tightness in the
banking system’s liquidity, which included reduction in
SLR, while keeping rates on hold as expected.
“Since then, banking system liquidity has gradually
improved from an ‘excessive deficit’ mode and carries
promise to improve further during February-March on
government spending,” stated a Barclays Capital report.
Beyond Market 04th Feb ’11
“The sequential softening in inflation until November
and the RBI’s stated preference for a near-term pause
earlier triggered expectations of policy rates staying on
hold until March,” the report added.
Despite the hawkish rhetoric during its last policy
announcement on 16th Dec ’10, economists at Barclays
Capital believe that the RBI would have ideally avoided
a January rate hike in case of a stable inflation print and
no fresh pressure on inflation expectations.
The unexpected rise in the December inflation print has,
however, turned out to be a game changer, and had been
the key to push the central bank to front-load another rate
hike in January, despite the source of the pick-up coming
largely from volatile food articles.
“The current inflation spike is almost entirely due to a
supply shock, for which monetary policy is not as
effective,” stated the report, wherein the economists
factored in a further hike of 75 basis points in the repo
rate during 2011, with a renewed front-loading bias.
On the monetary and liquidity scenario, while the y-o-y
money supply growth at 16.5% in December ’10 was
close to RBI’s indicative projection of 17%, non-food
credit growth at 24.4% was much above the indicative
projection of 20% set by the RBI.
“Credit expansion in the recent period has been rather
sharp, far outpacing the expansion in deposits,” said
Subbarao. “Rapid credit growth without a commensurate
increase in deposits is not sustainable.” Tight liquidity
conditions persisted throughout the third quarter of
2010-11, for which the RBI has announced the extension
of the liquidity measures to address the still tight domestic
liquidity conditions.
Firstly, the additional liquidity support to scheduled
commercial banks under the liquid adjustment facility
(LAF), currently set to expire on 28th January, was
extended to 8th April. Secondly, the second LAF (SLAF)
will be conducted on a daily basis until 8th April.
The RBI has been quite vocal about the fact that the
effectiveness of the monetary policy is muted in the
presence of a large fiscal deficit. So, all eyes are now set
on the coming budget in February, wherein the fiscal
picture would get clear.
If the fiscal situation is not able to tackle inflationary
pressures well, the RBI may hike rates again in its next
mid-quarter review in March. So, for now, pause is past
and the steps that the RBI has been taking periodically
since mid-March ’10 are set to continue. A lot depends
on how the numbers play up in the coming weekS.
It’s simplified...
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