The Reserve Bank of India (RBI) kept all rates unchanged in line with consensus and
our expectation. The repo rate stands at 4.75% and the reverse repo rate at 3.25%, while the CRR of banks is at 5%.
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The RBI raised its inflation target from 4% to 5% for end-March 2010 in line with our expectations. Giving a direction to future policy, the RBI stated that it will “maintain an accommodative stance until there are robust signs of a recovery”, and thereafter “reverse the expansionary measures to anchor inflation expectations and subdue inflationary pressures.”
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It kept its growth forecast unchanged at 6% but added ‘an upward bias’ to it. The RBI also increased its broad money (M3) target from 17% to 18%. It sees risks to the upside for both its GDP and inflation projections.
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In the policy statement, the RBI listed its future challenges as four-fold. First, manage the balance between the short-term compulsions of providing ample liquidity and the potential build-up of inflationary pressures on the way forward. Second, to manage the government’s borrowing program. It noted that in the first half of FY10, Market Stabilization Scheme (MSS) bonds unwinding and planned purchases of government securities will add liquidity of Rs. 1500 bn (US$ 31 billion). Third, to spur private investment demand which have been dented by the crisis. Fourth, the need for a comprehensive fiscal consolidation programme.
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In our view, the rate decision and policy statement signals a move away from a sole focus on boosting demand to giving more weight to inflation. Inflationary pressures have been acknowledged explicitly and the WPI target revised upwards. We think the RBI has adequately judged the balance of risks, and provided a comprehensive delineation of challenges going forward. The policy statement departs from previous ones in its transparent articulation of the RBI’s thinking.
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There is a clear message to the government to get its fiscal house in order, by not only indicating deficit reduction targets but giving out details of adjustment on the revenue and expenditure front. The details on RBI’s management of the government borrowing program we think will reassure bond markets that the financing of the deficit will be manageable.
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The policy confirms that there will be no more rate cuts and therefore takes away a small overhang on the INR. We think that capital inflows due to the strong structural growth story will continue to put upward pressure on the INR and our 3, 6, 12m target remain at 47.3, 46 and 44.7 respectively.
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The RBI statement gives more support to our view that the RBI will start hiking interest rates in early 2010, due to latent inflationary pressures and strengthening aggregate demand. At the first instance, however, we think the RBI will start by withdrawing liquidity towards the end of 2009.
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Our WPI inflation forecast, at 6.5% for end-March 2010 remains higher than the RBI’s revised target of 5%, while our projection for GDP growth at 5.8% is in line with the RBI’s target of 6%.
- Tushar Poddar, Vice President & Chief Economist, Goldman Sachs India