INDIA POLICY – RBI hikes but also signals a pause ::CLSA

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INDIA POLICY – RBI hikes but
also signals a pause
In its midyear policy review, the RBI announced an
expected 25bp hike in the repo rate to 8.5%. With
this increase, policy rates have been effectively
raised by 525bp since early 2010. Also, RBI finally
cut its GDP growth forecast for FY12 to 7.6%
(CLSA: 7.3%) from 8% but retained its March 2012
inflation forecast of 7% (CLSA: 7.5%).
Disappointingly, RBI avoided any FY13 guidance.
Importantly, the RBI indicated that “…the
likelihood of a rate action in the December midquarter
review is relatively low.” In an important
reform, it deregulated the savings bank deposit rate.
Essentially, on monetary policy, RBI is willing to
look beyond the still-elevated readings for October
and November, and focus more on the anticipated
decline in inflation beginning December. The timing
of the improvement in inflation is in line with our
expectation, and we anticipate further meaningful
improvement in 1Q12, to 7.5% by March 2012.
Why RBI favours such time-bound guidance
remains a mystery; a similar guidance late last year
had actually backfired.

Digging deeper, there are contradictory elements in
the policy statement. There are three parts to the
RBI’s monetary policy: (1) rate action; (2)
justification for the hike; and (3) guidance. RBI’s
concerns over high inflation and inflationary
expectations, and sticky and generalised inflation
underscore the rate hike. Less clear is the reason
for RBI to be willing to see through the expected
high inflation readings for October and November
to signal a pause in December but prefer not to
pause now for the same reason. Quite frankly, its
time-bound dovish guidance, which cheered the
local bond market, is at odds with the rate hike.
Further, RBI has been slow in acknowledging and
acting on the palpable signs of moderation in
growth. Indeed, its new-found focus on the
deceleration in investment activity should have
come some months earlier.
An embarrassing part of the policy statement is
how the RBI assesses the trend of de-seasonalised
inflation data: it now concludes that this indicates
moderation, consistent with its inflation projection.
Just six weeks ago, in the September policy
statement, it guided, “The inflation momentum,
reflected in the de-seasonalised sequential monthly
data, persists.” It is hard to imagine that the
dramatic difference between the two views is due
mainly to just one month’s WPI data.
RBI’s inflation trajectory is similar to ours even
though there is a marginal difference in the March
2012 inflation (RBI: 7%, CLSA: 7.5%). We
maintain that RBI will now remain on hold and
will shift to an easing stance sometime between
April and June 2012. Admittedly, as before, there
are legitimate risks to the inflation trajectory from
the uncertainty regarding the nature, timing and
magnitude of the likely increases in some local
administered prices needed to check the fiscal
slippage and from global commodity prices.