rbi to hike repo, reverse repo rates by 50 bps

Corporate Laws and Indirect Taxation Laws Practitioner.

India's policy response to the economic downturn has been very swift with RBI cutting repo rate by 425 basis points in a span of 6 months and CRR by 400 basis points in just three months. With the economic recovery gaining ground, despite rising inflation, RBI went slow on withdrawing accommodative policy. It was a calibrated move given the risk of snapping growth which was in a nascent stage. However, with robust pick-up in consumption demand, recovery in private capex gaining momentum, early signs of improvement in credit growth and inflation becoming more broad based than merely led by drought-impacted rise in food prices, it is time to move away from excessively accommodative monetary policy towards a neutral policy regime. Along with the economy going through its second highest inflation phase in the decade, RBI also faces the challenge of managing highest ever net annual government borrowing programme in a smooth and non-disruptive manner. Corporate and consumer credit off-take is likely to gain momentum due to improving consumer and business confidence. Further, higher oil price will increase under-recoveries of down-stream oil companies and increase credit demand from this sector. Given such a scenario, higher government borrowing programme may have a crowding-out effect on private sector credit and thereby significantly impact interest rates in short-to-medium term. All these factors will have a significant bearing on RBI's monetary policy over the next one year. We expect RBI to display optimism on economic growth and set its FY11 GDP growth projection at 8.25% with an upward bias even though concerns on core inflation is likely to be elevated due to surge in global commodity prices, strong domestic demand and supply constraints. RBI's surprise rate hike in the month of March 2010 clearly flagged its concern over rising broad-based inflation expectation. Policymakers continued thrust on driving consumption through stimulus has put consumption drivers in top gear however, despite low interest rate regime due to aftermath of global financial crisis capex growth has been lackluster. We expect capex to pick up aggressively in the next 12-18 months which will further propel credit growth. However, in the interim, surging manufacturing inflation remains a key risk. Despite RBI being behind the curve in rate normalization till now, we expect acceleration in rate hike going forward which will play a crucial role in shaping outlook for near-term economic growth. We expect RBI to hike repo and reverse repo rates by 50 bps in either its scheduled policy meet on 20th April 2010 or soon thereafter. On an average, Rs 12000 cr of G-Sec auction is planned every week. So, RBI is unlikely to aggressively absorb excess liquidity from the system which is currently to the tune of Rs 50,000 crore. Over the course of next one year, we are likely to see Repo rate, Reverse Repo rate & CRR rising by 100 bps each. In our views, managing government borrowing programme is not a staggering task, albeit at an elevated cost. It is going to defining moment for RBI to manage growth and inflation tussle simultaneously without impacting other but in my view this time the focus should be around Inflation than growth because it is cause of concern that we see signs of higher inflation at such early stage of uptrend in the business cycle. 

 
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