RBI hints at rate hike, sees price pinch

RISING INCOMES MAKE FOOD COSTLY

THE Reserve Bank of India said high food prices may stay despite bountiful monsoon as rising incomes puncture the theory that 'supply-side factors' kept prices high, a shift that sets the stage for a sixth interest rate rise this year.
    "The expected dampening impact of a normal monsoon on food inflation may not materialise, unless the rabi production improves substantially and (changes are made in) the policy on food management," the RBI said in its report on Macro and Monetary Developments. "Anchoring inflation expectations in such an environment is a difficult challenge for monetary policy."
    This is a move away from what the policymakers believed in July.
    "A good kharif harvest will act as a major dampener on
short-term food price inflation," governor Duvvuri Subbarao said during the first quarter policy review on July 27.
    But Mr Subbarao need not stick to the line of his research department when he reviews monetary policy on Tuesday. Food prices rose 13.75% in the week ended October 16.
    "Downward rigidity in inflation at an elevated level has resulted despite a normal monsoon and range-bound international oil prices," the report said.
    The view of using interest rate increases to contain soaring prices is now gaining currency after policymakers and politicians in the past believed that monsoon would lead to higher farm output and cool prices. The political class has been for keeping rates low to maintain the 8.5% growth momentum, but the central bank has been fearful of spiralling inflationary expectations.
    "The hawkish comments on inflation suggest the RBI may raise rates," said Indranil Pan, chief economist at Kotak Mahindra Bank, according to Bloomberg News. "A pause now can cause a disruption in the policy transmission that is underway."
    Traders and economists are divided on what the governor should do. Some believe the central bank should pause since industrial output growth has been slowing. Others believe that optimism is high and some structural factors such as rising incomes could accelerate the inflationary pressures.
    Conflicting signals emerge with the wholesale prices at 8.6%, though off its peak, industrial output growth at a 15-month low and core industries growing a meagre 2.5% in September.
    "The high volatility in the data relating to the industrial sector in general and capital goods sector in particular has raised issues about how effectively the data reflect the underlying momentum," said the report. FROM MINT ST
On Growth Rate
Economy on track to meet central bank's projected 8.5% growth on the back of a normal monsoon, but industrial output data a worry
On External Sector
Capital inflows have helped fund the current account deficit, but the potential volatility of such flows poses some risk
On Liquidity Conditions
Liquidity has been tight since May 2010, in the wake of transfer of 3G/BWA auction proceeds to government
On Inflationary Situation
Normal monsoon seems to have had a less-thananticipated impact on inflation. Higher inflation continues to remain a challenge for policymakers.
On Global Revival
There has been a slowdown in global recovery, with projections that it could extend up to the first half of 2011. Also, advanced economies may go in for further quantitative easing Real sector in trouble
MOSTnow expect a 25-basis point increase in the rate at which banks borrow from the central bank and for deposits with it. The reverse repo rate, which banks are paid when they deposit excess funds with the central bank, is at 5% and the repo rate, which banks pay to borrow from the RBI, is at 6%. The cash reserve ratio, the portion of deposits that banks keep with the RBI, is at 6%.
    Volatility in the industrial output data does not adequately reflect the 'underlying momentum' in the industrial sector, the central bank said, a view similar to non-reliability of the inflation data in the past that made policy decisions difficult.
    High growth rates may not be sustained if investments don't accelerate and if cheaper imports eat into the demand for locally made goods, it said. The RBI is also worried about the impact of a possible second round of quantitative easing that could slosh the emerging markets, including India, with strong capital inflows. Everything is not hunky dory in the real sector too. The RBI's order books, inventories and capacity utilisation survey indicates that capacity utilisation, which had remained range-bound since the second quarter of 2009-10, declined during the first quarter of 2010-11. The level of business optimism has improved as indicated in RBI's industrial outlook survey.