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RBI's crusade against inflation continues

Equitymaster , Last updated: 17 September 2011  
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The Reserve Bank of India (RBI) declared its mid-year monetary policy review for financial year 2011-12 today. High fuel prices, persistent inflation and expectations of liquidity overhang in global financial markets drove the RBI to tighten the monetary policy noose for the 12th time since March 2010.

The RBI raised the rates at which it lends to banks (repo rate) by 0.25%. Thus the repo rate now stands at 8.25% from 8.0% previously. The rate at which RBI borrows from banks (reverse repo) now stands 7.25% post the review. The central bank left the cash reserve ratio (CRR) unchanged at 6%.

The RBI reiterated that inflation is a huge risk factor that cannot be ignored. Thus the central bank decided that it was too early for it to roll back its earlier stance.It fears that such a move would dilute the effect of the actions undertaken over the past 18 months.

Battling high inflation and slower growth

Headline inflation measured as Wholesale Price Index (WPI) rose from 9.2% in July to 9.8% in August 2011, continuing to remain stubbornly high despite the central bank’s efforts. The oil marketing companies (OMCs) recently responded to high crude prices by hiking petrol prices by Rs 3.14 per litre across the country. Currency depreciation and higher crude prices globally are putting pressure on India’s oil bill and OMCs’ bottom line. According to the RBI, the petrol hike is expected to have a 0.07% direct impact on the WPI. Food inflation in country is also above comfort levels. This is despite a good monsoon this year. However, inflation may ease towards the latter half of the fiscal year even if it is under pressure for the next couple of months according to the RBI.

The global economy has seen a slowdown over the last quarter. There are renewed fears of recession on the back of the Euro sovereign debt crisis. A slowdown in the US economy is also highly apparent. Emerging economies on the other had have seen growth, albeit at a slower rate. In India, GDP growth decelerated to 7.7% in 1QFY12 from 8.8% in 1QFY11. The Index of Industrial Production (IIP) slowed from 8.8% YoY in June to 3.3% in July 2011. However, on removing the change in capital goods which is usually volatile, the fall was not as sharp. Rather than keeping growth intact, the RBI continues to target inflation, unlike its other counterparts in other parts of Asia and Brazil.

The path forward

High crude oil prices, steep industrial commodity prices and the RBI’s monetary tightening will weigh on India’s economic growth in the near term. A weak global economic environment and rupee depreciation (which hurts imports) are also worrying factors. Money supply growth and credit growth were above RBI’s projections in August 2011. However, in light of the latest round of tightening and the faster transmission of monetary policy, credit growth may see a further dip. Consumer demand is expected to slowdown, which could help in cooling inflation. Growth in sales of interest rate sensitive products like passenger cars has already been impacted. Corporate profits have also fallen on account of higher borrowing costs. The RBI expects its monetary policy actions to play a part in bringing down inflation. Even though the central bank is well aware of the counterproductive impact of steep interest rates, the balancing act between growth and inflation control is a tough one.


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Equitymaster
(Analyst)
Category Shares & Stock   Report

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