JPMorgan, India: RBI sticks to script – hikes by 25 bps and signals there is more to come

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India: RBI sticks to script – hikes by 25 bps and signals there is more to come

In line with expectations, RBI hikes policy rates by 25 bps and signals there is more to come The central bank reiterates that inflation remains significantly above its comfort zone and worries that any premature change of monetary stance would risk further hardening inflationary expectations The RBI acknowledges global concerns but points to the fact that, despite global softening, crude prices remain elevated and could further pressure inflation at home The RBI indicates that risks to its FY12 growth forecast of 8% are to the downside, on account of a slowing global and domestic economy Despite that, the central bank explicitly signals a persistence of its anti-inflationary stance; we therefore expect another rate hike at the October review and are not ruling out more rate hikes after that   RBI sticks to script   In line with expectations (Consensus and JP Morgan: 25 bps), the RBI raised the repo rate by 25 bps at its September mid-quarter review. As a consequence, market reaction was relatively muted. Equity markets and the INR hardly reacted, while the 1Y OIS and bond yields rose 4-5 bps, but more on account of the RBI’s hawkish guidance (see below) than today’s move, per se.   In rationalizing its decision, the central bank reiterated that current inflation levels remain high, generalized and “much above the comfort zone of the Reserve Bank.” They admitted that while domestic growth may be moderating, demand pressures still persist as evidenced by strong pricing power across most sectors. The RBI also specifically alluded to the fact that the latest IP print was overstating the weakness, by pointing out that ex-capital goods, IP growth actually accelerated in July -- something we have repeatedly flagged since the time of the release (see, “India: IP plunges but it’s not as bad as it looks,” Morgan Markets, September 12, 2011).   All that said, the RBI indicated that risks to their GDP growth forecast of 8% for FY12 were to the downside, induced by persistent global weakness and slowing domestic demand (JP Morgan forecast: 7.6%)   Today’s move influenced by inflationary expectations   A key motivation behind today’s rate hike was on anchoring elevated and rising inflationary expectations. The RBI made repeated references to this throughout their policy document, explicitly stating that a “premature change in the policy stance could harden inflationary expectations, thereby diluting the impact of past policy actions.”   The RBI’s concern on hardening inflationary expectations seems well justified. Quarterly surveys, for example, suggest household inflationary expectations have hardened over the last year despite the RBI’s repeated moves. The latest survey in June pointed to the fact that households expect inflation a year ahead to be close to 13% -- an increase of almost 2 percentage points over the previous year.     RBI expresses concern on the global front but points to elevated global crude prices   Calls for an RBI pause by various market participants were predicated on rising global uncertainty and softening global activity. The RBI acknowledged these concerns. Specifically, the policy statement admitted that the global macroeconomic outlook has worsened and that recent global developments were a matter of great concern.   However, it also pointed to two offsets. First, that while the growth momentum in advanced economies is weakening, growth has remained relatively resilient in emerging and developing economies. Second, and more pertinently from India’s inflation perspective, it pointed out that despite a weakening global economy, global crude prices have remained elevated. Elevated crude prices and a depreciating INR, for example, prompted India’s oil marketing companies to raise petrol prices by almost 5 percent the day before the policy, which is expected to pressure inflation by another 7-8 bps. The larger point, however, is that rising global risk aversion in recent weeks has caused a significant INR depreciation but no corresponding price relief of global commodities. This makes inflation management more, not less, difficult for the RBI – something that was alluded to in the statement.     Make no mistake: there’s likely more to come   With today’s action largely expected, what was being watched with more anticipation was the guidance the RBI would give for the future. For those that had hoped or expected that the rate hike cycle was coming to an end, there was little relief.   The RBI struck a hawkish tone and indicated as clearly as it could that it was not done just as yet. Specifically, the policy statement noted that “it was imperative to persist with the current anti-inflationary stance.” With inflation and inflationary expectations unlikely to moderate substantially in the coming months and growth expected to slow gradually, we expect the RBI to raise policy rates again at its October review, and perhaps even after that, until there is clear evidence that inflation is on a path of sustained moderation towards the central bank’s comfort zone.