There could not have been a more opportune time for me to write this article. With every passing day since the last year, Dr Subbarao’s job is getting increasingly tougher. With inflation still keeping up against RBI and absence of significant structural actions on Government’s part to control inflation, options for policy actions with RBI have been reducing. With the whole onus of managing inflation falling on RBI, I think it is apt to rename RBI as suggested in the title of the article.

Here is my take on recent monetary policy review-

Rates

Reserve Bank of India (RBI) continued treading on its rate hike road yet another time. This twelfth rate hike in last 18 months did not come as a surprise especially after inflation, (measured by any index, right now WPI) increased by 9.78% during August compared to 9.22% in the prior month. The repo and the reverse repo rates after the hike stand at 8.25 percent and 7.25 percent respectively while the CRR (cash reserve ratio) and the SLR (statutory liquidity ratio) rates stand unchanged at 6 percent and 24 percent respectively. There were muted expectations in the markets that policy rates might be kept at the same levels while SLR or CRR ratios might be altered. In my opinion, these ratios are used for different purposes.(Read about different policy rates and purposes) With liquidity conditions mostly in shape, barring last week when borrowing on Repo window increased to even around Rs 1,00,000 crore due to advance tax payment, RBI is unlikely to tinker with CRR or SLR atleast in the current scenario.

Banks

Commercial banks are likely to see deterioration in the NIMs. RBI has been stressing on the need to increase the deposits growth and going easy with credit growth. While credit growth has moderated to around 20% in August’11 compared to 21% in March this year, moderation is not substantial. Deposit growth still trails at 18% presently compared to 16% in March. As indicated by SBI, this increase in costs will be passed on to borrowers in a short time. With receding demand, I don’t see a lot of takers at higher rates level. Deposit rates might also see an upward revision simultaneously to stimulate the deposit growth. This, in all probabilities is likely to eat up a portion of banks’ NIMs.

Inflation

On inflation front, RBI has continued with its tough stance (RBI Statement) against inflation. However, the guidance given on inflation this time has been more optimistic than last time. In its Policy review statement, RBI has mentioned its expectations regarding softening of inflation-

  • “As monetary policy operates with a lag, the cumulative impact of policy actions should now be increasingly felt in further moderation in demand and reversal of the inflation trajectory towards the later part of 2011-12”
  • “Inflationary pressures are expected to ease towards the later part of 2011-12. Stabilisation of energy prices and moderating domestic demand should facilitate this process”
  • Views on normal monsoon and a record production of grains “Monsoon rains so far have been normal. The first advance estimates for the 2011-12 kharif season point to a record production of rice, oilseeds and cotton, while the output of pulses may decline”. This might be taken as an expectation that food prices might decrease

However, it also expects that for the coming few months, inflation will remain high. It also gives certain factors which are likely to continue adding to inflationary pressures – “….there is still an element of suppressed inflation. Though global oil prices have moderated, the pass-through to domestic prices remains incomplete. Also, current administered electricity prices are yet to reflect increase in input prices, even as many states have initiated increases. Food inflation is at near-double digit levels, despite normal monsoons, underlining the fact that it is being driven by structural demand-supply imbalances and cannot be dismissed as a temporary phenomenon. The inflation momentum, reflected in the de-seasonalised sequential monthly data, persists”.

My Take

With growth scenario slowly also sluggish, many analysts have started expecting a pause in the rate hiking spree. Global outlook has only worsened in the recent months. Exports are unlikely to continue with the current momentum due to this. On domestic front, IIP growth has been moderating with extreme volatility. This has led Central Bank to indicate that there are downside risks to 8% growth projection in the July review.

I will take it more as an indication from RBI that the rate setting committee is prepared to see the current high levels of inflation for coming couple of months and expect it to start moderating from atleast the last quarter of the current fiscal. Stance of monetary policy has been kept unchanged clearly to keep inflationary expectations at bay. Further rate hikes cannot be ruled out but I feel that the same will be taken only if inflation figures increase beyond this point. Base effect will be pretty high from this point onwards especially during December and January due to over 130 bps Month on month increase during these months in the last fiscal. This atleast on the face will keep inflation figures under control and induce a wait and watch approach of RBI.

 

Author: Praveen Bajaj

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