RBI raises policy rates; guides for a persistent anti-inflationary stance: Edelweiss

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The Reserve Bank of India (RBI) lifted both repo and reverse repos rates by 25bps, to 6.50% and 5.50% respectively, thereby maintaining the LAF corridor at 100bps. It left CRR unchanged. The policy was hawkish on inflation and cited it as the dominant concern. RBI acknowleged its limited role in directly controlling inflation that has continued to rise owing to structural constraints in the agri sector and rising commodity prices globally. Hence, key motivation behind the policy move was to contain the spillover from rise in food and fuel prices to generalised inflation and to rein in rising inflationary expectations. In its guidance, RBI said that it will continue its anti-inflationary monetary stance given the growth and inflation dymanics.

Further, RBI extended additional liquidity support to banks to up to 1% of net demand and time liabilities (NDTL)  until April 08, 2011. This was since the existing level of liquidity tightness is above RBI’s comfort zone, despite better liquidity conditions. Going forward, the central bank expects liquidity conditions to ease with government spending picking up further.

On the macroeconomic front, RBI is comfortable with the current economic growth, but is concerned over inflation, the widening current account deficit (CAD) and risks to fiscal consolidation (as it was based on one-off receipt and, hence, is unsustainable). What also worries RBI is the impact on inflation from government subsidies (they may keep supply-side inflationary pressure in check over short term, but could negate the benefit by adding to aggregate demand). RBI increased the base line projection for WPI inflation for March 2011 to 7.0% from 5.5%. It retained real GDP growth forecast at 8.5% for FY11 and expected CAD to be ~3.5% of GDP in FY11.

Owing to structural demand-supply mismatches in non-cereal food items, high commodity and fuel prices, sticky non-food manufacturing inflation and some evidence of rising demand pressures, inflation is expected to remain uncomfortably high. This would require measures which would contain inflation and anchor inflationary expectations. Therefore, going ahead, we expect RBI to continue its interest rate tightening cycle, with further hike of 75bps likely in the current calender year.