RBI Monetary Policy Preview Back on the inflation trail: Angel Broking

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RBI Monetary Policy Preview
Back on the inflation trail

In the forthcoming RBI Monetary Policy Review on January 25, 2011, we expect the

central bank to raise both repo and reverse repo rates by 25bp each to 6.5% and 5.5%,

respectively. The possibility of a 50bp hike also cannot be ruled out. We expect the RBI

to keep the statutory liquidity ratio (SLR) and cash reserve ratio (CRR) unchanged at

24.0% and 6.0%, respectively.

Expect a 25bp hike, but not ruling out the 50bp hike

In the last policy review, the central bank had not raised the repo and reverse repo rates

but had indicated it to be a temporary pause. For improving liquidity in the system, the

RBI had cut the SLR by 1.0% to 24.0% in the last policy review. However, with WPI

inflation rising to 8.4% in December 2010 from 7.5% in November 2010, much above

the RBI’s comfort zone, monetary tightening spree is likely to start once again.

Food inflation has also accelerated pretty rapidly from 8.6% yoy for the week ended

November 20, 2010, to the peak of 18.3% for the week ended December 25, 2010.

On the other hand, industrial growth showed some signs of slowing down, with

November 2010 IIP growth slowing down to 2.7% compared to average growth of

12.6% in the past 12 months.

Though the problem of inflation seems to be more affected on account of supply-side

issues; internationally, central banks have historically raised policy rates in the scenario

of rising inflation even if economic growth is not so high (as can be seen in Exhibit 3).

For instance, during mid-1970s and early 1980s, crude oil prices jumped up sharply,

which hampered economic growth and at the same time resulted in high inflation in the

US. The US Federal Reserve (US Fed) aggressively resorted to monetary tightening

despite the recessionary environment and essentially a supply-side inflation issue.

Hence, looking at the high inflation in India at present, we believe the RBI will once

again resume monetary tightening, with anchoring inflation its top priority rather

than growth.

Do not expect a CRR hike due to persistently tight liquidity

conditions

System liquidity has been persistently tight with liquidity adjustment facility (LAF)

window borrowings averaging ~`1,10,000cr since its last policy review on

December 16, 2010. Hence, we expect the RBI to hold on to the current CRR and

SLR at 6.0% and 24.0%, respectively.