Expect More shocks from RBI this April

As inflation spread to non-food articles, the Reserve Bank of India (RBI) acted fast. The move which was expected in RBI's annual policy, came in a tad early. On Friday (March 19), the central bank raised key policy rates by 25 basis points (bps) to tame inflation and anchor inflationary expectations by raising. This marked the reversal of its easy monetary policy regime. Inflation, which touched 9.89% in February, is projected to touch double-digit level next month.

From the horse's mouth

RBI deputy governor KC Chakrabarty was in no mood to "predict" future hikes. How inflation will behave in the months to come depends on two variables—global oil prices and nature on monsoons. He said the the decision to hike key policy rates just now was taken as all economic indicators were urging for an action. He said the RBI is yet to set a new inflation target for the next fiscal year.

Deputy Chairman of the Planning Commission, Montek Singh Ahluwalia, said the RBI was expected to watch the price trend before deciding further action. “The central bank would watch ‘underlined momentum’ for further action.” The RBI action is the 'end of downward adjustment' of rates, he added.

More hikes in April?

However, market veterans including Anantha Narayan of Standard Chartered Bank and Rajeev Malik of Macquarie Capital Securities see a 25-50 bps hike in the April policy.

“Another 25 bps repo, reverse repo hike in April is likely along with a 25-50 bps move on cash reserve ratio (CRR),” said Malik, adding that a cumulative rate hike of 100-125 bps is seen though 2010.

To which, Narayan added that the reverse repo might head to 4.5-5% in the near term. “We could see yields spike up to 8.5%.”

Malik however sees a meaningful impact on leading rates only in the second half of this calendar year.

The rational

The RBI's two-page press note announcing the rate hike had the word inflation writ large in every line. The central bank had pointed out that food prices, despite some moderation in the last few weeks remain at an elevated 16%; the consumer price indices have been rising in recent months.

The second reason for the hike is the robust recovery numbers. Industrial output grew at 17.6% in December and at 16.7% in January. In addition a 39% rise in capital goods in December and a 56% rise in January show that investment activity has revived.

However, Malik feels that political pressures could have prompted the surprise rate hike.

An increase in the repo and reserve repo rates signals an increase in interest rates. In January, The central Bank had raised CRR by 75 bps. The repo rate and the reverse repor rate were last hiked in July 2008 (by 50 bps) and June 2006 (by 25 bps), respectively.