RBI to continue to combat inflation:: Angel Broking

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The growth momentum in the Indian economy continues to be strong. Real GDP
growth was 8.8% during 1QFY2011, which was the highest quarterly growth recorded
since 3QFY2008. Also, despite some moderation in recent months, IIP grew by
10.6% during April-August 2010, as compared to 5.9% during the same period in
2009. While credit growth has been hovering around the 20% mark targeted by the
RBI, inflation continues to be stubbornly high at 8.6% yoy, well above the RBI's target
of 6.0%. As of now, the trade-off seems more favourable on restraining inflation.
Hence, we believe the RBI would find it prudent to continue the process of gradual
domestic monetary tightening.
Accordingly, we expect the RBI to hike repo and reverse repo rates by 25bp each to
6.25% and 5.25%, respectively. However, considering the current liquidity situation,
we do not expect a CRR hike in the coming policy.



Focus on anchoring inflationary expectations
Until February 2010, food and textiles contributed as much as 70% to the overall
9.9% WPI inflation, on account of the drought-driven increase in prices of food
grains, sugar and cotton, among others. By September 2010, their contribution to
the 8.6% WPI, though on a downward trend, was still high at 49%. The oil segment's
contribution increased to 16% from 11% of the overall inflation. Contribution of
other items (having 55% weightage in the WPI index) increased to 35% in September
2010 due to increased prices of coal, metals, electricity and wood products, among
others, indicating that inflation is becoming more broad-based. Therefore, monetary
tightening to anchor inflation expectations is appropriate at this juncture. As per the
RBI, inflation rates have reached a plateau, but are likely to remain at unacceptably
high rates for some months.


Over the next few months, we expect inflation to moderate from the peak levels seen
in the recent months. However, the RBI has noted certain upside risks to inflation
such as:
�� International commodity prices, particularly oil, have started to increase again.
In several commodities, the import option for India to contain domestic inflation is
limited because of higher international prices.
�� The revival in private consumption demand and the bridging of the output gap
will add to inflationary pressures.
�� It is important to guard against the risk of hardening of inflation expectations
conditioned by near double-digit headline WPI inflation.
Accordingly, we expect the RBI to hike repo and reverse repo rates by 25bp each to
6.25% and 5.25%, respectively. In any case, it should be noted that interest rates are
well below peak levels, leaving ample scope for gradual monetary tightening, without
adversely affecting the growth outlook.



Liquidity situation may prompt a hold on the CRR front
Since the previous mid-quarter monetary policy review by the RBI on
September 16, 2010, liquidity in the system has completely dried up, as reflected in
the bank’s average borrowings of ~`58,300cr from the RBI. The decline in liquidity
has been primarily on account of continuous lagging of deposit growth as compared
to credit growth and steady stream of big-ticket primary issuances.
On October 29, 2010, banks borrowed ~`1,17,700cr from the RBI, which was the
highest since October 10, 2008.
As a result of the above developments, the 10-year benchmark G-sec yields have
hardened from 7.98% as of September 16, 2010 to 8.13% as of October 29, 2010.
Thus, the current liquidity situation may lead the RBI to delay any CRR hike in
contemplation.