RBI Policy: Hike or pause? Markets reconcile to Reddy surprise Tuesday, Jul 29 What will be the surprise this time? "Quantum" of the action, or "instrument" of action or absence of an action? Even as Reserve Bank of India governor prepares his swansong, his apparent penchant for "surprising the market" is making most veteran Mint Street watchers say that no amount of preparation will ensure they read Reddy right. There will be some surprise. He meeting the street expectation will be surprise too. "You just can't be sure you will get him right." "While we are all talking about the repo rate, he may just hike the reverse repo and the Bank Rate too, Successive polls by kences1 have showed that most dealers in banks, primary dealerships, stock brokerages, mutual funds, and corporate treasuries expect Governor Y.V. Reddy to raise the repo rate by 25 bps. Some of them see a hike in cash reserve ratio, but a wider lot don't see a CRR hike just now because liquidity is already tight. Some respondents claim they "won't be surprised" if Reddy just reads out a hawkish statement and not put any of the monetary tools to use. Fall in crude oil prices and early signs of moderation in GDP growth are reasons enough for a pause, they say. But, quiz them deeper, they admit "that will be a surprise" as inflation is near 12% and absence of any measure could bolster inflationary expectations. Inflation has sped to a 13-year high of 11.89% for the week to Jul 12. RBI aims to bring down inflation to around 5.5% by March end. The government, which took a slew of fiscal and administrative steps earlier this year to cool the prices, has now thrown the ball in RBI's court, saying the central bank's monetary measures will be the "first line of defence" against inflation. . "SURPRISE" PAUSE? Despite the evident inflationary pressures, some analysts see a case for Reddy not resorting to any monetary tightening just now. ICICI Securities Primary Dealership attaches a 30:70 probability to RBI not hiking interest rates. It is mainly betting on a 25 bps hike in repo rate. "After slamming the brakes in the inter-meeting period, skipping rate action in the policy review is pretty much in line with RBI's modus operandi," A. Prasanna, an economist with ICICI Securities Primary Dealership. He hastens to add that his firm is open to be "surprised" by a hike in the reverse repo rate. Those who see a pause say the central bank will bark loud, but bite less today because it has already hiked interest rates by 75 bps and CRR by 125 bps since April. "It may wait to see the impact of the past measures," a Singapore- based swap,iterating the theory that the central bank's monetary actions work with a lag. kences1 poll of about 40 dealers conducted Monday showed that around 26% of the respondents expect the central bank not to take any measures today. A similar poll conducted on Jul 21 showed that 23% of the respondents had expected a pause in monetary tightening. Apart from softening oil prices, there are other variables that could prompt Reddy to hold interest rates and banks' cash reserves, After rising sharply each successive week since early February, inflation rate has started showing signs of stabilising. "After spiking up by 3 percentage points in June, headline WPI inflation has held steady around 11.90% over the last three readings," Contribution of primary articles of incremental inflation has come down, while the contribution of manufacturing and fuel has held steady. Money supply growth too has started to slowdown. On last reading, it grew 20.5% on year on Jul 4, compared with a year on year growth of 21.4% a month ago. Although, it is way above the 16..5-17.0% growth target set by RBI in April, the central bank could take comfort from the slowing money supply. "I think RBI will maintain status quo. The pace of inflation rise has come down. Also, it will take time for earlier monetary measures to take effect," said V. Balakrishnan, chief financial officer, Infosys Technologies. . HIKE - NO SURPRISE! RBI hiking interest rates by 25 bps won't surprise many given that inflation is at a 13-year high. The Macroeconomic and Monetary Developments Report released by the RBI Monday emphasises that oil price pass-through is incomplete and, therefore, inflation stays pressured up. And with oil prices still ruling above $100 a barrel, any comfort on inflation is unlikely. Crude oil prices have lost $22 a barrel from the record highs of $147.27 a barrel seen on Jul 11, but analyst say it is an uneasy softening as oil prices could climb back up. Analysts also say that RBI may have to keep the monetary policy tight with hikes in CRR to balance the slippage in government finances expected this year. Ahead of the elections next year, the government's expenditure is expected to stay high and, therefore, have consequences on inflation. The government has to also implement the 650-bln-rupee farm loan waiver scheme and implement the recommendations of the Sixth pay commission. The central bank will have to ensure an appropriate rate setting so that inflationary expectations don't build again. "We will have to see what tool the RBI uses," said a bond trader. "It used a sledgehammer in the last two month. Will it follow up with equally harsh measures or come with milder moves remains to be seen. What should be certain is that they will be at it," a dealer said. "Chances are that Reddy may be more hawkish than everyone expects him to be," said Ramya Suryanarayanan, economist at DBS Bank. "Chances are that Reddy may signal that this is not the end of the rate hike cycle. There is a lot of uncertainty over the slowdown in the U.S. and its impact on India. The Governor would have to balance this pessimism with (by pointing out) high inflation." Markets abhor high interest rates. But Governor Reddy had to resort to monetary tightening during most of his tenure, which earned him the reputation of being an inflation hawk. Reddy was believed to be "ahead of the curve" when he raised interest rates citing inflationary pressures at a time when not many others saw inflation.. Now, when inflation has zoomed to close to 12%, he is believed to have fallen behind the curve. Some say inflation spiral was beyond his control as he has no say over international commodity prices. But few blame him for inflation saying he allowed a loose monetary policy--by letting money supply growth top 20% for two years. What will Reddy, whose tenure ends in September, offer in his last monetary policy statement? |
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