India: Now It is Their Turn for Possible Rate Hikes

Yes, India’s central bank did leave its short-term interest rates unchanged today (29 January 2010). However,it raised banks’ cash reserve requirements by a higher-than-expected 75 basis points. This is to be implemented in two phases and indicative of rising inflation.

“Though the inflationary pressures in the domestic economy stem predominantly from the supply side, the consolidating recovery increases the risks of these pressures spilling over into a wider inflationary process,” it said in its third quarter review.

The Reserve Bank of India (RBI) said the CRR would be increased by 50 basis points from Feb 13 and a further 25 basis points to 5.75 per cent from Feb 27.

It held its lending rate, or the repo rate, unchanged at 4.75 per cent and its reverse repo rate, at which it absorbs surplus cash from banks, unchanged at 3.25 per cent.

Despite increasing inflationary pressures, the central bank has been under pressure from senior government officials to hold off from raising its policy rates, which they argue would undermine the economic recovery.

The central bank lifted its wholesale price index inflation forecast for the end of the fiscal year in March to 8.5 per cent from its earlier forecast of 6.5 per cent, but said it expected inflation to moderate starting in July, assuming a normal monsoon and global oil prices holding at current levels.

It also lifted its forecast for GDP growth in the current year to 7.5 per cent, from an earlier target of 6 per cent, and said that the current rate of growth is likely to be sustained in the financial year that ends in March 2011.

The bank rate, used by banks to price long-term loans, remained unchanged at 6.0 per cent.

A Reuters poll last week showed 24 out of 25 economists expected the RBI to raise bank reserve requirements, or the cash reserve ratio, by up to 50 basis points.

Most economists had expected the central bank to keep core interest rates on hold, and Indian overnight indexed swap rates had ruled out a rate rise.

The cash reserve ratio was cut by 4 percentage points in five moves between October 2008 and January 2009 as the central bank moved to support the economy during the global financial crisis.

The RBI had cut the repo rate by 4.25 percentage points in six steps between October 2008 and April 2009. The reverse repo rate was cut by 2.75 percentage points in four steps since December 2008.

The RBI joins other central banks in Asia in taking steps to start unwinding ultra-loose monetary policy. Yesterday, the Philippines raised a short-term lending rate, and this month China started to tighten policy by raising banks’ reserve requirements and accepting higher yields at bill auctions.

Australia was the first Group of 20 country to begin raising rates as the global economy recovers from its worst downturn since the Great Depression. The Reserve Bank of Australia has raised its key cash rate by 75 basis points since October.

So it looks like growth is around the corner and fears of inflation have compel central banks to head off such pressures before they can bubble in.