A calibrated exit

COMMENT: Sonal Verma, India Economist, Nomura Financial Advisory

The key point of contention in the RBI’s policy meeting was whether it would opt for a more gradual 25-bps or a more aggressive 50-bps policy rate hike. By opting to hike repo and reverse repo rates by 25-bps each, RBI has showed its preference to move in a calibrated manner given the fragile global environment.

RBI acknowledges it needs to do a fine balancing act between absorbing excess liquidity to manage inflation, while at the same time ensuring that government borrowings are not hampered and that it does not choke off the economic recovery. This suggests the reverse repo will remain the operating rate corridor at least until September, since the borrowing calendar is front-loaded.

 

According to RBI, real policy rates are still negative and, therefore, further rate hikes are necessary. However, this process of normalisation will be calibrated, suggesting that RBI will continue to hike policy rates in incremental 25-bps steps. This gradual withdrawal of easy monetary conditions is positive for growth. Already, lead indicators are suggesting a revival in investments. With normal monsoon and improving jobs market, consumption growth should remain well-supported. We are more optimistic than RBI on growth (we expect GDP growth of 9 per cent in FY11).

Inflation is still very much a concern. RBI expects inflation to moderate from mid-2010 onwards, falling to 5.5 per cent in March 2011 from 9.9 per cent in March 2010, due to the normal monsoon. However, this is an optimistic assumption in our view. WPI inflation in a number of commodities such as oil and metals is still suppressed, input costs pressures are high and output gap is narrowing at a fast clip. All of this suggests that inflation is likely to stay higher for a longer period.

Overall, the policy didn’t throw up any surprises.