RBI wary of sharp rise in global commodity prices

The market expects 25 bps increase in key rates in the next review.

For the first time this financial year, the Reserve Bank of India (RBI) did not raise key policy rates during a review. Analysts, however, term this as temporary. Rising commodity prices would put pressure on headline inflation, which, in turn, might compel the central bank to increase rates as early as January, analysts said.

While RBI refrained from any action on the rate front, it sounded hawkish on inflation, primarily due to rising global commodity prices.

“Despite slow recovery and slack capacity in advanced economies, international prices of commodities like oil, food, industrial inputs and metals have risen significantly in the recent weeks. Reflecting the strength of demand and higher commodity prices, inflation has started creeping up in most emerging economies,” RBI said.

As a result, market participants expect at least a 25 basis points (bps) increase in key rates in the next policy review on January 25.

“Despite the recent moderation in inflation, input cost pressures persist due to sticky domestic food inflation and rising global commodity prices. In its forward-looking statement, the central bank said there was need for continued vigilance against build-up of demand-side pressures. This suggests a likely hike in the January 25 review,” said Sonal Verma, an economist at Nomura Securities.

A Deutsche Bank research note sees a 75 bps rise by March to tame inflation. “We see RBI remaining hawkish beyond Thursday’s temporary pause, leading us to forecast a 25 bps rise in rates when it meets next. We look for a further 50 bps rise through the rest of the year, taking the repo and reverse repo rates to seven and six per cent, respectively,” the note said.

The wholesale price index-based inflation for November has come down to 7.48 per cent, as against 8.58 per cent in October. However, this is higher than the central bank’s projection of 5.5 per cent for March 2011. Food inflation moderated from an average of 15.7 per cent in the first quarter to 12.3 per cent in the second. It fell to 10 per cent in October and was just 6.1 per cent in November.

However, RBI said moderation in inflation for cereals and pulses had been larger than that for protein-related items such as egg, fish, meat and milk, reflecting the structural nature of food inflation. In addition, inflation for non-food primary articles such as raw cotton, raw rubber and minerals rose sharply.

“Though inflation has moderated, pressures persist both from domestic demand and higher global commodity prices. There is risk that rising international commodity prices will spill over to domestic inflation,” RBI said.

Going forward, RBI sees rising domestic input costs for the manufacturing sector, combined with aggregate demand pressures, weighing on domestic inflation. “The risk to RBI’s projection of 5.5 per cent inflation by March 2011 is on the upside,” it added.