RBI Policy Review - RBI turns aggressive; hikes repo rate by 50bps:: Edelweiss

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The Reserve Bank of India (RBI) raised repo rate by 50bps to 7.25%, with reverse repo rate getting automatically adjusted to 6.25% under the new operational procedures. FY12 growth projection has been placed at ~8% with downward bias, while inflation is projected at ~6% for March 12 with an upward bias. RBI’s response was more aggressive than its past approach of calibrated tightening of 25bps at a time. The latest move clearly shows that the central bank is willing to sacrifice growth to rein in inflation. This action not only reinforces RBI’s inflation-fighting credentials, but also reflects its belief that low and stable inflation is necessary for sustaining growth over medium term. However, the effectiveness of RBI’s policy actions would be seriously undermined if government continues to support demand through loose fiscal policy. From this perspective, if government allows retail fuel prices to rise, it may contribute to higher inflation in the near term; however, in the long term, the outcome will certainly be favourable as it will help curtail the aggregate demand, a target that RBI is trying to achieve.

Going forward, monetary policy dilemma, for RBI, is likely to increase as growth moderates and inflation remains elevated at least in H1FY12. Nonetheless, at this stage, inflation concerns are clearly dominating growth concerns. We see this anti-inflation stance to continue, with RBI hiking the policy rate by another 50bps through the remaining CY11.