Rate rise remains a done deal

Inflation remained elusive and stubborn at near double-digit levels for several months. Inflation in May, at above nine per cent, turned out to be yet another upside surprise. Pressures remained widespread, with food, energy and manufacturing prices all contributing in large quantum.

Non-food manufacturing inflation – a commonly tracked proxy for core inflation – remained elevated at above seven per cent. The glimmer of hope was the relatively smaller revision in headline inflation in March.

The Reserve Bank of India (RBI) has clearly said it would accord the highest priority to rein in rising prices and if required, it would do so at the cost of near-term growth. Of late, there has been a renewed bout of uncertainty and risk aversion in the western world.

 

However, RBI currently does not have an option, but to focus on domestic concerns. A rise of 25 basis points (bps) in policy rates should be a done deal after the latest wholesale price index print. A 50-bps rise, however, would be a bit too harsh. The tone of the policy is likely to stay ultra-hawkish as well.

However, in my view, it is almost impossible for the central bank to match the combination of ultra-hawkish action and tone, as was the case at its last month’s policy meeting (ultra-hawkish statement, 50-bps rate rise, 50-bps rise in savings bank rate, the introduction of marginal standing facility at 100 bps above the repo rate). Beyond June, we expect RBI to deliver another repo rate rise of 25 bps in the third quarter of 2011 before taking a pause.

The writer is economist, Barclays Capital