Reserve Bank of India Tightens Again

September 16, 2011

Because of a darkening global macroeconomic outlook, many central banks have paused monetary policy regardless of their domestic circumstances.  The Reserve Bank of India is not one of them.  A twelfth interest rate increase since March 2010 has been implemented today, with the repo rate raised 25 basis points to 8.25% and the reverse repo going from 7.0% to 7.25%.  There were six increases in 2010 totaling 200 basis points and another six moves so far this year also totaling 200 bps.

Indian monetary officials were motivated in part by a rise of inflation to 9.78% last month from 9.22% in July, 9.44% in June and 9.06% in May.  Although they anticipate better price numbers in 2012, they also believe that it would be premature to let up on the monetary brakes just yet.

Inflationary pressures are expected to ease towards the later part of 2011-12. Stabilisation of energy prices and moderating domestic demand should facilitate this process.  However, in the current scenario, with the likelihood of inflation remaining high for the next few months, rising inflationary expectations remain a key risk. This makes it imperative to persevere with the current anti-inflationary stance.

The monetary tightening effected so far by the Reserve Bank has helped in containing inflation and anchoring inflationary expectations, though both remain at levels beyond the Reserve Bank’s comfort zone.  As monetary policy operates with a lag, the cumulative impact of policy actions should now be increasingly felt in further moderation in demand and reversal of the inflation trajectory towards the later part of 2011-12.  As such, a premature change in the policy stance could harden inflationary expectations, thereby diluting the impact of past policy actions.  Going forward, the stance will be influenced by signs of downward movement in the inflation trajectory, to which the moderation in demand is expected to contribute, and the implications of global developments.

Reserve requirements were left unchanged at 6.0%, and the marginal standing facility rate was held at 9.25%.  The next policy review will be done in early November.

Copyright 2011, Larry Greenberg.  All rights reserved.  No secondary distribution without express permission.



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