Cycle of rise in key policy rates may be extended

The cycle of upward revision in key policy rates by the Reserve Bank of India (RBI) is likely to be extended, owing to the high prices of commodities, according to economists. Many economists also said the pricing power of producers posed upside risks to inflation.

Market observers have now revised their outlook on policy rate increases, following higher-than-expected inflation in March. To tame rising inflation, RBI may raise rates by 75-100 basis points in the current financial year, they say.

The Wholesale Price Index (WPI)-based inflation in March stood at 8.98 per cent — higher than market expectations of around 8.5 per cent and RBI’s projection of 8 per cent.

Accordingly, economists have reconsidered their forecasts for the new financial year. “This (rise in inflation) has increased the possibility of the rate hike cycle continuing longer than our and the market’s current expectations of 50 basis points. We are putting our rate hike views under review,” Goldman Sachs economists said in a report.

Samiran Chakraborty, head of research (India), Standard Chartered Bank, revised his outlook for the rise in rates in 2011, raising it from 50 basis points to 100 basis points, the inflation figures for march were announced. “The central bank faces a more acute growth/inflation dilemma than at any time in the recent past. This tightening would lead to growth risks but it is better to engineer a soft landing rather than wait for a hard landing to bring down inflation,” he said in a report.

The inflation figures for March is a provisional figure. This means there are chances of the figure crossing the double-digit mark, once it is revised after two months. WPI inflation figures for January and December were up by 100 basis points each after revision.

In its mid-quarterly review on monetary and credit policy, RBI said it continued to maintain an anti-inflationary stance. It said as domestic fuel prices were yet to adjust completely with global prices, the risks to inflation remained on the upside. The belief was reinforced by the persistence of demand-side pressures that were reflected in non-food manufacturing inflation.

The inflation dynamics for financial year 2011-12 are now looking even more adverse than our earlier understanding, even as the government continues to dither on increasing prices of administered fuel products, said economists at Kotak Institutional Securities. Compared with their earlier projection of a rise of 50-75 basis points, they now expect policy rates to rise by 75 basis points in the current financial year.