JP Morgan: RBI expectedly raises rates by 25 bps; signals continuation of anti-inflationary stance

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India: RBI expectedly raises rates by 25 bps; signals continuation of anti-inflationary stance

RBI raises policy rates by 25 bps in line with market expectations and signals continuation of its anti-inflationary stance March inflation forecast revised up to 8% oya from 7% on non-food manufacturing and oil price concerns RBI expresses concern on slowdown of investment momentum and its implications for growth in FY12 While encouraged by the extent of fiscal consolidation being attempted in FY12, the Central Bank worries about higher-than-budgeted subsidies pressuring expenditure management RBI reduces its FY11 current account deficit forecast to 2.5 % of GDP from 3.5% of GDP RBI expectedly raises policy rates by 25 bps As was widely expected, the RBI raised policy rates by 25 bps at its mid-quarter review today and also signaled a continuation of its anti-inflationary stance (see, “India: RBI likely to hike rates on March 17 as February inflation remains stubbornly high”). The repo rate was raised to 6.75 % from 6.5% and the reverse repo rate was raised to 5.75% from 5.5%. With February inflation accelerating to 8.3% driven by a sharp increase in non-food manufacturing inflation (whose sequential momentum is currently running close to double digits), a rate hike at today’s mid-policy review was a foregone conclusion. Furthermore, with the RBI repeatedly emphasizing a “calibrated” approach to monetary tightening, market participants had correctly anticipated another 25 bps increase. March inflation forecast now revised up to 8% The RBI has again revised up its March inflation forecast to 8% oya (JP Morgan: 8 %). Recall, March inflation had been forecast to print at 5.5% by the RBI till as recently as December. It was revised up to 7% in the January review and has now been revised up again, more realistically, to 8% oya. The fact that the March inflation has been revised upwards by a whopping 250 bps over the last two meetings, and policy rates have only been hiked by 50 bps suggests a disconnect between the central bank’s concerns and actions. In revising up the March forecast, the RBI identified the upside risks stemming from elevated international crude prices and their impact on freely priced petroleum products in India. Their concerns on this score seem justified as weekly inflation numbers for the first week of March released today revealed a sharp increase (3.6 % week-on-week) in fuel prices. More importantly, the RBI expressed concerns at the sharp increase in non-food manufacturing inflation in February, reflecting increasing demand pressures in the economy. While the RBI cited the increase in the year-on-year rates of non-food manufacturing inflation from 4.8% in January to 6.1 % in February as a cause for concern, it is important to note that on a sequential basis (q/q, saar), non-food manufacturing is now running in excess of 9%, and this momentum has risen secularly for 5 straight months. Concerns rise about investment and growth While broadly reiterating its FY11 growth forecast of 8.5 % oya, the RBI cited concerns about the investment climate which, they believe, is being adversely impacted by continuing uncertainty about global energy and commodity prices. For several months we have been highlighting that the lack of investment momentum serves as a key downside risk for FY12 growth prospects (see, “IP slows further; investment cycle still missing in action,” November 12, 2010). With no evidence that the non-infrastructure investment cycle has turned out, we believe growth will decelerate next fiscal to about 8% -- which will not be undesirable from the standpoint of quelling inflationary pressures. RBI concerned about fiscal slippage…. While comforted by the headline fiscal consolidation in the Budget, the RBI expressed concerns that expenditure could be pressured by higher-than-budgeted oil and fertilizer subsidies. They emphasized that expenditure management was a key prerequisite to demand-side inflation management. As we have pointed out (see, “FY12 budget surprises positively but beware of the fine print,” February 28), the FY12 budget effectively targets an unprecedented fiscal consolidation (1.7 % of GDP) and slippages on account of subsidies (food, oil, fertilizer) are likely. Despite this, however, the consolidation will still be significant and thereby aid inflation management. ….but revises down current account deficit estimate In its January review, the RBI raised a hornet’s nest but suggesting that the FY11 current account deficit (CAD) could reach an “unsustainable” 3.5 % of GDP. As we have repeatedly pointed out (see, “Current account deficit concerns overstated,” February 10), the CAD was always expected to print below 3% of GDP on account of a fast shrinking merchandise trade deficit. In this mid-quarter review, the RBI significantly revised down its FY11 CAD forecast to 2.5 % of GDP. This appears likely both because of a lower-than-expected trade deficit as well as the fact that the CSO has revised up its estimates of market prices GDP for FY11, thereby resulting in a smaller CAD/GDP ratio. RBI signals continuation of anti-inflationary stance; expect more rate hikes Despite signaling concerns about investment and growth, the RBI explicitly stated that it will persist with its anti-inflationary stance. This is no surprise. With December inflation revised up close to double digits, and the momentum of non-food manufacturing inflation accelerating for five straight months, it is clear that the current inflation trajectory is significantly above the Central Bank’s comfort zone. As such, more rate hikes are expected in 2011 including a likely 25 bps hike at the next review on May 3.