RBI likely to hike policy rates

Ernst & Young India on Tuesday said that despite the steep fall in headline inflation in August, the Reserve Bank is likely to persist with monetary tightening measures by hiking key policy rates by at least 25 basis points at its mid-quarter review on Thursday.

"At 13.8 per cent, the July IIP numbers are indeed very encouraging. And going by this number, it is very clear that there will surely be an upward correction in the demand for funds in the coming months," E&Y India National Leader for Global Financial Services Ashvin Parekh told PTI.

"This in turn will lead the RBI to further hike the repo and reverse repo or short-term lending and borrowing rates by 25 bps in the September 16 review," Parekh said.

He further pointed out that the drop in headline inflation in August is primarily because of the large basket of items reflected in the new WPI inflation data.

"Therefore, it is unlikely that the central bank will be guided by the August numbers. More importantly, the RBI will look at rising food inflation, besides the comfortable liquidity situation in the system, coupled with industrial expansion, which would be demanding more and more credit from next month onwards," Parekh pointed out.

The government on Tuesday released a new index for measuring wholesale price inflation, which revealed that prices rose by 8.5 per cent on average in August vis-a-vis the base year of 2004-05.

As per the old series with a base year of 1993-94, WPI inflation stood at 9.5 per cent for the month, according to the Commerce Ministry. Overall inflation in August witnessed a fall of 1.27 percentage points from 9.78 per cent in July, as per the new series, which considers 2004-05 as the base year.

In the first quarter monetary policy review on July 27, the RBI had hiked repo rate by 25 bps to 5.75 per cent and reverse repo by 50 bps to 4.5 per cent, while leaving the cash reserve ratio unchanged at 6 per cent.

This was fourth successive hike since the January policy review. Parekh, however, felt there is no room for the central bank to take a harder than 25 bps hike as the inflationary pressures are waning now, thanks to the efficient supply side management by the government in the recent months.

Food inflation for the week ended August 28 stood at an elevated 11.47 per cent after falling to under 10 per cent in early August. The general inflation based on wholesale prices had declined to single digit in July at 9.97 per cent, after being in double-digits for five months.

"Beginning next month, the now low credit off-take will get a major fillip with the corporates increasing their capacity addition as well as expansion. Going by our estimate, the economy is expected to log in 9 per cent growth this fiscal and to achieve that, companies have to expand their capital expansion plans aggressively," he said.

"I see index of industrial production (IIP) clipping at 14-15 per cent through the rest of the months on the back of an expected 20 per cent capital expansion by the corporates through the rest of the fiscal," Parekh said.

As of end-August, the credit growth has been a tepid 18 per cent against the industry's as well the RBI's projection of 22 per cent. Last week SBI Chairman O P Bhatt had said that "at around 18 per cent, credit off-take has not been matching the expectation of the bankers and the RBI."

Further explaining the rationale for a rate hike, Parekh said, the RBI move to deregulate savings and current accounts (CASA) deposit rates will automatically see that the cost of funds would go up.

"I see up to 75 bps jump in the cost of funds for banks as and when savings rates are deregulated," Parekh said, and argued that there is a huge gap in savings account and fixed deposit rates now. Another enabling factor for the RBI to hike the rates is the comfortable liquidity situation in the system, he said, and pointed out that it has also the cushion of not needing to manage a large government borrowing immediately.

"There is not much strain on the liquidity system." Also, the high fund inflow into the system ensures that there is no reason for the government and the RBI to hold onto a low interest rate, Parekh said.

On whether he sees an asset bubble build-up on the back of rising FII investments, he said, "going by the way the inter-bank money market is behaving, there is no such signs now."

"But if the capital markets gain over 5-10 per cent in the short-term, then there is a room for concern. But I don't see that happening in short to medium term."