July inflation numbers harden case for RBI rate hike in September

Sanjiv Shankaran

Headline inflation in July was 9.22 per cent, largely in line with market expectations. Moving beyond the headline number to disaggregated data showed Reserve Bank of India's (RBI's) reading of the situation in the recent past has been spot on and there could be another increase in interest rates next month.

"I would see one more round of interest rate hikes, given the current information," said NR Bhanumurthy, a professor at the National Institute of Public Finance and Policy (NIPFP).
 
The information that may play a critical role in RBI next monetary policy announcement on 16 September is the trend and magnitude of non-food manufacturing, or core inflation. Core inflation in July was 7.5 per cent, higher by 30 basis points in relation to the previous month.

Monetary policy's biggest impact tends to be on core inflation by compressing demand, and the upward movement over the last few months in core inflation is what RBI has been trying to check through interest increases.

"RBI is still odds on to raise the policy rate by 25 bps (basis points) during its September 16 policy meeting, in our view," Taimur Baig and Kaushik Das of Deutsche Bank, said in a research note on July inflation data.

Since March 2010, RBI has raised its policy rate, or repo rate (the rate at which banks borrow from RBI), 11 times to the current level of 8%.

RBI has emphatically reiterated in its recent policy statements that fighting inflation is its foremost priority. To be more specific, anchoring inflation expectations has been the aim of monetary policy as stable expectations are expected to create the right environment for sustainable economic growth.

"Poorly anchored inflation expectations make long-term financial planning more complex with potential adverse effects on investment and growth," Deepak Mohanty, executive director of RBI, said at a speech in Allahabad on 13 August.

The aim of monetary policy is to restrict perceptions of inflation to 4% to 4.5%, Mohanty added.

With inflation prevailing above 9 per cent for most part of 2011, the direction of monetary policy is unlikely to change in September. Subsequently, developments in Europe and US, particularly the steps taken by their central banks to boost economic growth, may begin to significantly influence the course of monetary policy in India.