Rajan surprises yet again, raises repo by 25 bps
For the fourth time in a row, Raghuram Rajan surprised the market and proved pollsters wrong as he decided to hike the key interest rate or the repo rate by 25 bps to 8% during the third quarter review of monetary policy.
This is the third occasion RBI hiked interest rate since Raghuram Rajan took charge in September. Since then, the repo rate has been hiked by 75 bps to tackle inflation which stayed stubbornly high.
CPI inflation, however, came down to a three-month low of 9.87% in December compared with 11.16% a month ago – which was record high. The Wholesale Price Index (WPI) inflation also fell to five-month low in December at 6.16% compared with 7.52% the previous month.
During the mid quarter policy review in December, Rajan decided to hold rate despite an uptick in inflation as he wanted to wait for more data and he also expected inflation to soften on the back of fall in vegetable prices. That Rajan has gone for a rate hike despite inflation softening in December is what has baffled the market participants.
RBI, however, justified its action on the ground that CPI inflation stayed at double digit levels and an uptick on non-food manufacturing inflation. In addition, wage pressures are also evident as inflation is high with respect to services.
“It clearly shows that price stability remains the pre-dominant objective of RBI's monetary policy. They have accepted CPI led inflation as the nominal anchor because WPI has eased substantially. Today's move will go a long way in controlling inflation and inflationary expectations," said Rupa Rege Nitsure, chief economist, Bank of Baroda.
The silver lining was the external sector, according to RBI, as for the first time in three years, the current account deficit is expected to fall below its comfort zone, which is 3%. RBI predicts the deficit to narrow to 2.5% of GDP for 2013-14 as compared to record high of 4.8% in the previous fiscal.
The third rate hike in five months come despite growth continues to be fragile and RBI expects growth to lose momentum in the third quarter. While it appears growth – in the central bank’s priority list – has taken a backseat but Rajan ruled out any trade-off between growth and inflation, in the long run.
“Do you think if we cut interest rate now, banks will cut deposit rates? No, because inflation is high and the depositor wants a real rate of return," Rajan said in a post policy press conference. RBI expects growth for 2014-15 to be around 5.5%, as compared to 5% in current fiscal.
However, the comforting factor is further rate hike in the current year is not seen by experts and that has also calmed the markets after a knee jerk reaction.
According to the central bank the extent and direction of further policy steps will be data dependent and also said inflation comes down further policy tightening in the near term is not anticipated.
“For now, this should mark the peak of the rate hike cycle, with the central bank’s growth projections close to our conservative estimates at 4.8% for FY14 and 5.3% for FY15," said Radhika Rao, economist, group research, DBS Bank.
While banks will be keen to pass on the rate hike by increasing lending rates, but lack of credit demand may come in their way, said experts.
“This is the fourth quarter in which banks expect liquidity tightness. But this year liquidity is comfortable and credit demand is very lacklustre due to which there is no pricing power left with banks. Scope for base rates hikes looks difficult," Nitsure said.
However, she added that while base rates may be left unchanged but banks may increase the spread over the base rate to protect their margins while deposit rate hike in not seen on the back of comfortable liquidity.
Source : Smart Investor
For the fourth time in a row, Raghuram Rajan surprised the market and proved pollsters wrong as he decided to hike the key interest rate or the repo rate by 25 bps to 8% during the third quarter review of monetary policy.
This is the third occasion RBI hiked interest rate since Raghuram Rajan took charge in September. Since then, the repo rate has been hiked by 75 bps to tackle inflation which stayed stubbornly high.
CPI inflation, however, came down to a three-month low of 9.87% in December compared with 11.16% a month ago – which was record high. The Wholesale Price Index (WPI) inflation also fell to five-month low in December at 6.16% compared with 7.52% the previous month.
During the mid quarter policy review in December, Rajan decided to hold rate despite an uptick in inflation as he wanted to wait for more data and he also expected inflation to soften on the back of fall in vegetable prices. That Rajan has gone for a rate hike despite inflation softening in December is what has baffled the market participants.
RBI, however, justified its action on the ground that CPI inflation stayed at double digit levels and an uptick on non-food manufacturing inflation. In addition, wage pressures are also evident as inflation is high with respect to services.
“It clearly shows that price stability remains the pre-dominant objective of RBI's monetary policy. They have accepted CPI led inflation as the nominal anchor because WPI has eased substantially. Today's move will go a long way in controlling inflation and inflationary expectations," said Rupa Rege Nitsure, chief economist, Bank of Baroda.
The silver lining was the external sector, according to RBI, as for the first time in three years, the current account deficit is expected to fall below its comfort zone, which is 3%. RBI predicts the deficit to narrow to 2.5% of GDP for 2013-14 as compared to record high of 4.8% in the previous fiscal.
The third rate hike in five months come despite growth continues to be fragile and RBI expects growth to lose momentum in the third quarter. While it appears growth – in the central bank’s priority list – has taken a backseat but Rajan ruled out any trade-off between growth and inflation, in the long run.
“Do you think if we cut interest rate now, banks will cut deposit rates? No, because inflation is high and the depositor wants a real rate of return," Rajan said in a post policy press conference. RBI expects growth for 2014-15 to be around 5.5%, as compared to 5% in current fiscal.
However, the comforting factor is further rate hike in the current year is not seen by experts and that has also calmed the markets after a knee jerk reaction.
According to the central bank the extent and direction of further policy steps will be data dependent and also said inflation comes down further policy tightening in the near term is not anticipated.
“For now, this should mark the peak of the rate hike cycle, with the central bank’s growth projections close to our conservative estimates at 4.8% for FY14 and 5.3% for FY15," said Radhika Rao, economist, group research, DBS Bank.
While banks will be keen to pass on the rate hike by increasing lending rates, but lack of credit demand may come in their way, said experts.
“This is the fourth quarter in which banks expect liquidity tightness. But this year liquidity is comfortable and credit demand is very lacklustre due to which there is no pricing power left with banks. Scope for base rates hikes looks difficult," Nitsure said.
However, she added that while base rates may be left unchanged but banks may increase the spread over the base rate to protect their margins while deposit rate hike in not seen on the back of comfortable liquidity.
Source : Smart Investor
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