RBI's hikes rates 12th time; gets mixed response from India Inc, bankers

As was widely expected, the Reserve Bank of India on Friday hiked the policy (repo) rate by 25 basis points to 8.25 per cent and said the rate of price rise remained "much above" its comfort zone.

This is the 12th straight rate hike since March 2010, as the monetary authority continues its war on inflation. Most observers expected the increase.

In his response to the Mid-Quarter Monetary Policy Review of the Reserve Bank, HSBC's Chief Economist for India and ASEAN, Leif Eskesen, said "The RBI hiked the policy rate to 8.25 per cent, in line with our call and consensus and the statement remained hawkish". 

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The RBI said it had little choice but to continue its tightening stance, as despite 12 rate hikes the year-on-year wholesale price index (WPI) inflation rose from 9.2 per cent in July this year to 9.8 per cent in August. At the same time, non-food manufactured products inflation rose from  7.5 per cent to 7.7 per cent, suggesting persistent demand pressures.

The oil marketing companies raised the price of petrol by Rs 3.14 a litre with effect from Friday. This, the RBI statement projected, will push up WPI inflation by 7 basis points directly, in addition to an indirect impact with a lag.

Despite the continuous rate hikes, the RBI statement said, inflation momentum remained, as did an element of suppressed inflation. This is because current prices did not fully reflect the increases in administered electricity prices and the higher global oil prices. The RBI is persisting with its anti-inflationary stand because it has found companies are still able to pass through higher input costs to consumers.

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"Corporate margins in Q1 of 2011-12 moderated across several sectors compared to their levels in Q4 of 2010-11. However, barring a few sectors, significant pass-through of rising input costs is still visible," the RBI said this morning in its policy statement.

This means demand pressures persist. Or, there is a need to dampen demand further. It is this that led many economists and brokerage houses to project at least one more rate hike before the RBI can be expected to contemplate a pause on rate hikes.

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"The RBI still rightly sees inflation as the dominant concern for India's domestically oriented economy and maintained the tightening bias, signalling that further hikes are likely," Eskesen said.

However, Kaushik Basu, the Chief Economic Advisor to the Finance Minister, created a flutter when he told reporters outside North Block, the seat of the ministry, after the RBI announcement that if he had a vote he would have voted for a pause on the rate hikes.

"Growth is being affected by what RBI is doing to control inflation. It is okay to make a short-term compromise to control inflation, but in the long run we want growth to remain high and buoyant," Basu reasoned.

Many analysts have taken this to mean there is a disagreement between the finance ministry and the RBI on managing inflation, especially since Basu was one of the candidates for the post of the RBI Governor before Subbarao's tenure was extended last month by two years.

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But soon after the RBI policy statement was announced, Finance Secretary R S Gujral had told Business Today: "The RBI has been doing a good job. This 25 basis point hike will have an impact on inflationary expectations."

So why did Basu say what he did?

It is true that the GDP growth fell to 7.7 per cent during April-June 2011 from 7.8 per cent in the previous quarter. But Basu's statement was less a criticism of the RBI and more a reminder to the government that unless it acts too, inflation cannot be tamed through monetary policy alone.

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Basu also chairs the Inter-Ministerial Group the United Progressive Alliance government constituted earlier this year to suggest ways to rein in inflation. "There are several tools cutting across nodal agencies that the IMG on inflation that I head have talked about. To curb inflation, the government needs to act on supply side management. And, there have to be fiscal policy measures in addition to monetary policy measures for there to be a pull-back in demand," Basu explained.

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The government has so far been content to take mini-steps such as banning exports of food products such as onions and monitoring supply of edible oils in its fight against inflation.

The RBI has consistently pointed out that much of food inflation is coming from a shift in demand patterns. For instance, increased intake of proteins as reflected in persistent inflation in milk and meat. (Mother Dairy raised its milk prices last week.)

The government, however, has taken no policy measure to augment supplies. "Food inflation is at near-double digit levels, despite normal monsoons, underlining the fact that it is being driven by structural demand-supply imbalances and cannot be dismissed as a temporary phenomenon," the RBI said in its statement this morning.

Basu's point on the need to control the fiscal deficit was echoed by the RBI this morning: "The central government's fiscal imbalances widened during April-July of 2011".

In fact, in May RBI Governor Subarrao had BT in an interview that dampening aggregate demand needed some fiscal steps in addition to monetary policy tightening.

Sacrificing growth - the inevitable fallout of rate hikes - so far hasn't brought down inflation substantially. if the government wants to control it, it must act on the advice from Basu and Subarrao.