BofA Merill Lynch says RBI likely to halt rate hike
It is no surprise that the Reserve Bank of India increased the
repo rate, for the twelfth time in a row, by 25 basis points from
8.0% to 8.25% with immediate effect.
Repo rate is the benchmark policy rate at which the central bank injects liquidity into the system by lending to banks. The RBI borrows from banks at the reverse repo rate. One basis point is one-hundredth of a percentage point.
Some analysts had predicted that the RBI may tone down its tightening monetary policy stance . According to the RBI, the global macroeconomic outlook has worsened since its first quarter policy review on July 26, 2011.
MUST READ: Is a tight monetary policy helping?
"There is growing consensus that sluggishness will persist longer than expected earlier. Concerns over the sovereign debt problem in the Euro area have added further uncertainty to the prospects of recovery," the RBI said in a statement.
More important, the domestic indicators have shown no signs of improvement. Food inflation stood at 9.47% for the week ended September 3, 2011, easing marginally from 9.55% in the previous week. In August, food inflation was at 9.78%, against 9.22% in July, despite a normal monsoon.
Further risks to inflation in September emanate from an increase in petrol prices and electricity prices which feed into the economy as a whole. Oil marketing companies raised the price of petrol by Rs 3.14 per litre with effect from September 16, 2011. This will have a direct impact of 7 bps on the Wholesale Price Index-based inflation, in addition to indirect impact with a lag, according to the RBI.
According to analysts, inflation is likely to persist at around 10% till September 2011. However, most analysts feel that we are currently at interest rate peak when compared with the last several years (see chart on key economic indicators, Summit Point).
According to a report by Bank of America Merrill Lynch, the interest rate cycle is nearly peaking and that the RBI will pause after the latest rate hike. The investment bank expects loan demand to slow down to 17% from the current 21%. This is likely to result in banks cutting their lending rates by 75 bps from the April-September 2012, which is a busy season for lenders.
In order to attract borrowers, several lenders, including ICICI Bank, HDFC and LIC Housing Finance, have already launched dual-rate home loans. The interest rate for the dual-rate loans is fixed for the first few years, after which the loan is shifted to floating rate.
According to Navneet Munot, chief investment officer, SBI Mutual Fund, the lagged effect of past policy actions by the RBI and the global environment would moderate the domestic demand and the inflation trajectory, going forward.
"One needs to watch out for the third round of quantitative easing (stimulus package) in the US, which is an immediate risk considering that a large part of these programmes call for money flowing into commodities, thus, raising prices and, in turn, inflation," adds Munot.
