Analysis: Reasons for a rate hike don’t hold water

It will be difficult for the Reserve Bank of India (RBI) to ascribe valid reasons for a rate hike on Friday, when it conducts a mid-term review of the monetary policy.

The primary indicators of liquidity, industrial growth, deposit and credit growth and portfolio flows are all down and look headed further south.

Inflation is the only issue facing the RBI and this has been factored in its previous rate hikes. Domestic factors, coupled with the turmoil in global economies, make for an extremely weak case for a rate hike.

The primary factors that the RBI tracks in framing policy are all showing their lag effect.

Liquidity has consistently been on the negative territory with the banking system borrowing around Rs50,000 crore on a daily average since the last policy review in July.

Industrial growth for April-July at 5.8% is 200 basis points (bps) lower than the same period in 2010.

Deposit growth and credit growth at 18.4% and 20.2%, respectively, are playing out as per the RBI’s expectations.

Incremental credit deposit ratio or ICDR for April 8 to August 20 is around 48%, well below an unsustainable 100% seen in March.
Credit growth has trended down from 22% in April to 20.2% now and given tight liquidity conditions and high rates outlook, the figure’s unlikely to be positive.

Portfolio flows into the equity market, which are considered ‘hot money’ by the RBI, is just around $250 million and in no way a threat to inflation.

The hikes, which took the repo rate up by 325 bps from 4.75% to 8% over the last twenty four months has increased the cost of borrowing in the economy by 250-350 bps depending on the entity.

The cost of borrowing of banks has moved up by 250 bps, while for lower-rated entities it’s up 350 bps in the last one year.
The high cost will filter down to lowering aggregate demand as it comes on top of higher prices.

Inflation has averaged 9.6% in the last fiscal, the highest in the last ten years. Investment projects do not become viable when there’s higher costs and higher interest rates.

Inflation at 9.78% for August is a touch higher than expected, since expectations were around 9.6%.    

However, the RBI has already factored in inflation of around 9.5-10% when framing policy.

The conditions for inflation to rise from here are not apparent given that monsoons have been good and commodity prices have been steady.

The Reuters CRB index, which tracks a basket of commodities including oil, metals and agriculture, is down 2% since July.
And the outlook for commodity prices is weak given downward revisions in global growth forecasts due to the debt and unemployment issues facing the developed world.

Ergo, slim chances of a rate hike, if at all.

— Arjun Parthasarathy is the Editor of  www.investorsareidiots.com, a web site for investors