Inflation seen forcing RBI hand again

The Reserve Bank of India (RBI) is likely to go in for another rate hike in the second quarter monetary policy review to be held later this month. A poll conducted by DNA including bankers, economists, insurers, fund managers and senior company officials reveals that the RBI will hike the repo rate (the rate at which banks borrow from RBI) by 25 basis points (one basis point is a hundredth of a percentage point) on October 25.

Accordingly, the reverse repo rate (rate at which RBI borrows money from banks) will also be hiked by 25 basis points to maintain the liquidity adjustment facility (LAF) corridor at 100 basis points.

With a further hike, repo rate will touch 8.50% from 8.25% and reverse repo rate will be 7.50% from 7.25%.

The hike in interest rates will hit growth further. “There are already signs of slowdown in the growth process of the economy and inflation is much above RBI’s comfort level. This will definitely affect the growth rate in the quarters to come,” said Samiran Chakraborty, chief economist with Standard Chartered Bank.

“After this rate hike (October 25) there should be a pause as the debt burden is increasing. Corporates are already going slow with their capex plans and investment activities have also slowed down in the last 3-4 months,” said Umesh Revankar, deputy managing director, Shriram Transport Finance Company.

There are a few who feel there is a need for fiscal policy measures to tame inflation. The two main instruments of fiscal policy are expenditure and taxation. The fiscal policy measures will directly impact the aggregate demand and the level of economic activities, resource allocation and income distribution.

Fiscal policies monitor the level of spending in the economy.
But the broad consensus is that there is little room for strong fiscal policies. This is mainly due to reasons such as subsidy payments on oil and also the recapitalisation of public sector units and other entities being under threat. These factors will make it difficult to the government to implement an expansionary fiscal policy.

Decline in tax revenues due to the reduced growth rate will force the government to have a controlled fiscal policy. “Without monetary policy it is going to be difficult to tame inflation. Given the current circumstances, fiscal policy measures are difficult to be implemented,” said Chakraborty. 

The wholesale price index inflation rose to a stubborn 9.78% in August while the September data, expected to be released later this month, will also be above the RBI’s comfort zone. If inflation does not come under control, the market expects rate hikes by the RBI even after the second quarter review of the monetary policy. “If that turns out to be adverse, then further rate hikes cannot be ruled out,” said Amarnath Ananthanarayan, CEO Bharti Axa General Insurance.