A Fifth Rate Hike in India

November 2, 2010

The Reserve Bank of India raised both its repo rate and reverse repo rates by 25 basis points to 6.25% and 5.25% and released a statement outlining the latest thinking of policymakers.  Four earlier increases were announced on March 9, April 20, July 2, and July 26 all of this year and, along with today’s action, cumulate to rises of 150 basis points for the repo rate and 200 bps for the reverse repo.

Officials are balancing some conflicting objectives.  Tighter monetary policy in India, unlike many other countries, is not merely a matter of returning the stance to more normal levels.  India has an inflation problem, which has spilled partly into expectations. “Notwithstanding some moderation in recent months, headline inflation remains significantly above its medium-term trend, and well above the comfort zone of the Reserve Bank.”  The central bank’s WPI baseline inflation forecast for March 2011 is unchanged from what was forecast in July.  An improving trend is predicated in part on the series of interest rate increases that officials are implementing.

It is, however, important to officials that economic growth not be overly disrupted by climbing interest rates.  So they are opting against shock and awe.  Real GDP in Asia’s third largest economy rose 8.8% in the year to 2Q10 and is likely to exceed 8% in both 2010 and 2011.  Tight liquidity conditions are also deterring RBI officials from tightening policy more aggressively.  Today’s statement observes that “even though a liquidity deficit is consistent with our anti-inflation stance, it needs to be contained within a reasonable limit to ensure that economic activity is not disrupted.”

Copyright Larry Greenberg 2010.  All rights reserved.  No secondary distribution without express permission.



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