Subbarao makes haste ‘fast’, ends behind-the-curve talk

The Reserve Bank of India (RBI) chose a very opportune moment to leap ahead of the curve on Thursday by asymmetrically yanking up policy rates (repo up 25 bps to 6%, reverse repo 50 bps to 5%) beyond street expectations.

Opportune, because the macros are fortuitously aligned for some pre-emptive action: the economy is thrumming extremely well, systemic interest rates trail the curve and the external situation, in the RBI’s own words, “is more resilient than feared”.

What better time to go hawkish, primarily to slay inflation, without fearing impairment to the economy?

And, were the global markets to turn wobbly down the road, the extra hikes are just the elbow room needed to adjust lower.

Primacy to price fight
The crux of Thursday’s attempt is to deal with a clutch of issues led by soaring prices, using the policy-rate weapon.
“Inflation remains the dominant concern in macroeconomic management,” the central bank said in a three-page statement.

“It appears to have stopped accelerating though the rate may remain high for some months,” the RBI said, noting the necessity for “continued policy response to contain inflation and anchor inflationary expectations”.

The RBI’s projection for inflation by this fiscal-end is 6%, which is
near its comfort range of 5% given 8-9% GDP growth.

“Inflation remains a dominant risk but it is the inflationary expectations and the stickiness that is bothering the RBI more,” said Shubhada Rao, chief economist at Yes Bank.

“As we understand from the statement, inflation is not likely to come off sharply. At 8.5%, it is still high and beyond comfort levels.”

Preferring repo, tight liquidity
The RBI mentioned its preference to have the repo rate as the effective policy rate. The message for banks in that is lucid, fend-for-yourselves stuff: it’s time to pay higher rates for deposits.

“The central bank pointed out that negative real rates have led to a deceleration of deposit growth, and that bank credit could become a constraint to growth,” points out Tushar Poddar, economist, Goldman Sachs.

Stabilising shorter rates
Not many economists expected the gap between the repo and the reverse repo rate to narrow because the RBI had set up an expert committee to examine the merits of a narrower policy rates corridor.

They felt the RBI would wait for the recommendations in order not to pre-empt the committee’s—being headed by RBI executive director Deepak Mohanty —findings.

But the central bank said it was narrowing the corridor to curb volatility in short-term interest rates should liquidity conditions change.

The shift to neutral
Will Thursday’s move mean a pause in hikes in the short term?
“I think we are pretty much at the end of rate-tightening cycle. May be we will have just one more round of rate hike of 25 bps repo and 25-50 bps reverse repo. The statement also indicates that RBI is reaching end of normalisation,” Abheek Barua, chief eonomist, HDFC Bank, said.

But the country’s chief economic advisor, Kaushik Basu, said nothing can be ruled out.

A Prasanna, vice-president, ICICI Securities Primary Dealership, sees a 50-50 chance of another rate hike in the quarterly policy review in November.

“In November, we expect the focus to be on inflation management in the context of strong growth despite global uncertainty,” Prasanna said.

Real rates & the new normal
With hopes of food prices easing in the coming months, the chatter over the pause in the tightening cycle had been gaining decibels.

The RBI acknowledged as much. The “tightening carried over this period (since October 2009) has taken the monetary situation close to normal”, it said in its statement.

ICICI’s Prasanna said till now, the normalisation process led to default rate hikes, but in future, moves will be based on economic data.

“Therefore, it is difficult to predict the next policy move,” he said. “Because the action will depend on inflation data.”

For Citigroup economist Rohini Malkani, the RBI statement was affirmation the monetary situation is close to normal.   

“...given that inflation remains significantly above trends, we expect one or possibly two more hikes in the next six months,” Malkani said.

But for Barclays Capital’s Rahul Bajoria inflation alone won’t be the criteria for deciding monetary policy.

Real interest rates are likely to turn positive in late December, when inflation subsides to 6% or below, reckons Bajoria, and does not expect further hikes in the repo rate.

However, chances of raising the reverse repo rate are left open due to the significance of narrowing the corridor.
Rupee to underperform

The RBI yet again highlighted the risks associated with the widening of current account deficit. Yet, says Goldman’s Poddar, and notwithstanding  portfolio inflows, India’s current account and broad balance of payments are worsening. “Therefore, the rupee may continue to underperform in the near term. On a trade-weighted basis the rupee may depreciate going forward. Our 3-, 6- and 12-month targets for dollar-rupee are 47.5, 44 and 43, respectively,” Poddar wrote.

Frowns at flighty IIP
On the domestic industry side, the RBI is worried - may be frowning would be more accurate — at the swings in industrial production data.

The Index of Industrial Production surged to 13.8% in July from 5.8% in June, a stunning rise helped by a 63% rise in capital goods index.

“...the high volatility over the past two months raises some doubts about how effectively the index reflects the underlying momentum in the industrial sector,” the RBI said.

In sum, governor Duvvuri Subbarao has raised rates by 125-175 basis points in the last six months, though he has said his guidepost was to “make haste slowly”. In the context, Thursday’s move looked post-haste.

Chitra Suresh of TickerNews and Aparna Iyer of Newswire18 contributed to this story.