Curbing inflationary expectations to take precedence

Expect repo rate to be hiked again

In its previous policy review, the Reserve Bank of India (RBI) had restored the normalcy of the LAF (Liquidity Adjustment Facility) corridor by raising the repo rate by 25 basis points to 7.75 per cent and reducing the MSF (Marginal Standing Facility) by the same amount to 8.75 per cent. The central bank had also increased the liquidity made available through term repos from 0.25 per cent to 0.5 per cent of the banking system’s NDTL (net demand and time liabilities). The policy was guided by concerns of elevated inflation levels, with both WPI (Wholesale Price Index)-based and CPI (Consumer Price Index)-based inflation trending higher.

WPI and CPI inflation have risen to 7.52 per cent and 11.24 per cent, respectively, primarily driven by food inflation. The impact of better kharif crop yield this year is still not discernible in the headline number. CPI has stood at more than nine per cent for 20 consecutive months and while the pace of rise in WPI-based inflation has slowed, a very significant moderation is not expected. At eight per cent, core CPI-based inflation, a measure of demand-side pressures in the economy, has also been sticky. It is expected both the headline inflation numbers won’t see a sharp fall.

For the quarter ended September, GDP (gross domestic product) growth inched up to 4.8 per cent from 4.4 per cent in the previous quarter, aided by the agriculture sector, though industry and services showed deceleration. GDP and IIP (Index of Industrial Production) numbers show lacklustre consumption and investment demand. As the government is determined to adhere to its fiscal deficit target of 4.8 per cent of GDP by curbing expenditure, growth may continue to remain muted. While RBI measures have definitely stabilised the rupee and eased concern about financing the current account deficit, which is now seen below $56 billion, these also seem to have impacted domestic demand, a prerequisite for sustainable growth in the long run.

Taking into consideration the evolving growth and inflation dynamics, RBI may be constrained to raise the repo rate by at least 25 basis points in the next policy review, to anchor inflationary expectations. Agriculture sector growth and increased clearances to infrastructure projects may result in better second-half growth numbers. With concern about the external sector receding significantly and the rupee seen stabilising at 60-63/dollar, RBI could further relax some measures on liquidity, by increasing allocation under the LAF or term repo.

Pradeep Madhav
Managing director, STCI Primary Dealer