Thursday, June 16, 2011

Monetary Policy: Pause still 50bps away

India Economics: Monetary Policy

The 25bps policy rate hike by the RBI today is on expected lines. The tone of the mid-quarter monetary policy statement was also hawkish as expected. Our inflation and growth estimates remain unchanged GDP growth at 8.2% and average inflation at 8% for FY12. The bias of monetary policy stance now is clearly anti-inflationary. We see another 50bps rate hike before the RBI can pause, contingent on the trajectory of global commodity prices and monsoon. 

Repo rates hiked by 25bps: RBI has hiked policy (repo) rate by 25bps, as widely expected by the market, bringing it to 7.5%. This automatically adjusts the reverse-repo rate and the marginal standing facility (MSF) rates to 6.5% and 8.5% respectively. All other policy rates (CRR, SLR, Bank rate) were left unchanged.

Hawkish tone as expected: The policy maker assumed a hawkish tone in the policy statement as expected. Given the revisions of March headline WPI inflation to 9.7, while May headline number at 9.1% had manufactured products' and core inflation at 7.3% and 7.2% respectively, the RBI maintained that "the monetary policy stance remains firmly anti-inflationary, recognising that, in the current circumstances, some short-run deceleration in growth may be unavoidable in bringing inflation under control."

Thus, concerns over inflation clearly outweigh concerns over growth moderation. Aggregate demand in the economy has slowed down, but still remain strong vis-à-vis output, as fresh capacity additions have fallen short in the last few quarters. As a result, despite some moderation in input prices of late, thanks to softening commodities, manufacturers have increased prices (with a lag) now to protect their margins, indicating persistence of still strong pricing power.

Our outlook on inflation, growth and policy rate: Our outlook for average inflation in FY12 remains at 8%, while the peak is now unlikely to overshoot 10.5% now (our earlier estimate was 11%), even with a fuel price hike (Indian Brent basket unlikely to hold strong for long; now ~$114). The revisions are likely to be capped at 30bps from April'12 onwards. Our FY12 GDP growth estimate remains at 8.2%. We believe that the RBI will need to hike rates by 50bps more before pausing. Global commodity prices along with the progress of the monsoon remain the key determinant now, besides fiscal policy stance.

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