India: RBI hikes by 25 bps; retains hawkish tone :: JP Morgan

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India: RBI hikes by 25 bps; retains hawkish tone

In line with our expectations, RBI hikes policy rates by 25 bps and continues to strike a hawkish tone RBI indicates that domestic inflation “risks remain high” and expresses concern about the generalized nature of inflationary pressures, as manifested by elevated core inflation levels The RBI reiterates that it’s stance remains “firmly anti-inflationary” even if this were to entail a short-run deceleration of growth The central bank indicates that there is no evidence of a sharp or broad-based moderation in domestic activity, and demand appears strong enough for producers to retain sufficient pricing power The RBI acknowledges that global economic conditions have worsened posing a downside risk to domestic growth but indicates that the balance of risks still tilts towards elevated domestic inflation levels     RBI hikes….   In line with expectations, the RBI raised the repo rate by 25 bps (Repo: 7.50 %) and continued to strike a hawkish tone. Consistent with the changes made to the operating corridor of monetary policy in the last review, the reverse repo automatically rose by 25 bps to 6.5 % and the marginal standing facility (MSF) rate (rate at which banks can now borrow from the RBI to the tune of 1 % of their liabilities) rose by 25 bps to 8.5 %.   ….and strikes a hawkish tone   Pointing out that “domestic inflation risks remain high”, the RBI indicated that even the current elevated rates of headline inflation are understating true inflationary pressures because (a) domestic fuel prices are yet to reflect global crude prices; and (b) recent elevated headline rates are likely to be revised further up when final prints are released.   Furthermore, the RBI continued to express “particular concern” about increasingly “generalized inflationary pressures”, noting that non-food manufacturing (RBI’s proxy for core) had risen to 8.5 % in the revised March print (on a sequential basis, it is running well in excess of double digits), indicating that producers retain significant pricing power and wage pressures and input costs are being passed on throughout the supply chain.   On the growth-inflation trade-off, it came out firmly in favor of fighting inflation, reiterating the view expressed in the last-review. Specifically, the RBI indicated that it’s stance remains “firmly anti-inflationary” and indicated that short-run deceleration in growth, as a consequence of bringing inflation down, may be unavoidable.   As such, we retain our central forecast of another 50 bps of hikes in this calendar year, which are expected to be relatively front-loaded. The risk, if any, is of more rate hikes if core and headline inflation levels continue to remain stubbornly high.   Monetary transmission working but domestic demand still strong…   The sharp moderation in April IP had created the sense in some quarters that domestic demand in India had begun to materially soften in 2Q. As we had pointed out, instead, (see, “IP moderates but exports rebound strongly and imports surge; RBI likely to hike by 25 bps,” MorganMarkets, June 10) April IP seemed more of an aberration because other indicators (non-oil imports, indirect tax-collections, credit growth) suggested that domestic demand remains solid. More generally, as we pointed out, looking at the IP trajectory more holistically over the last few months (especially the new IP series) conveys a rather different picture than just focusing on comparing the April print to the month before.   The RBI made exactly this point in their policy statement. They noted that, under the news series, IP remained relatively resilient over the last few months, and that growth in capital goods production remained buoyant. In addition, the statement also pointed to buoyant trade data, resilient corporate earnings in 1Q, and steady credit growth to underscore the point that this was not suggestive of a sharp or broad-based slowdown in the domestic economy. Recall, as we had noted, (see, “1Q growth moderates on a base effect; sequential growth strong,” MorganMarkets, May 31), even the moderation in 1Q GDP growth was based on a high base effect and that, on a sequential basis, growth actually re-accelerated in 1Q.   The RBI did acknowledge, however, that monetary transmission has begun to work, noting both that a vast majority of banks had raised their base rates in recent weeks and, more significantly, that there was a deceleration in interest-rate sensitive sectors (such as automobiles) but still no evidence of a more sharp or generalized moderation in economic activity.   …but global concerns rise   The RBI, however, indicated that global conditions have worsened since the last review, noting that high energy prices have caused future growth prospects to visibly moderate in the developed economies, while monetary tightening in the emerging markets is likely to cause growth to slow in those economies. All of this, along with uncertainty about the resolution of the sovereign debt crisis in the euro area, has increased the downside risk to global growth. That said, the RBI indicated that elevated global commodity prices continue to remain the key external risk for the conduct of monetary policy in India   As such, while acknowledging that a slowing global economy poses downside risks to domestic growth, the RBI indicated that the balance of risks is still tilted towards domestic inflation remaining elevated in the months to come, thereby necessitating a continuation of their anti-inflationary stance.