Apex bank unlikely to pause in the rate tightening cycle

Is it time to pause? The question asked by many on the forthcoming review of the first quarter of Monetary Policy of 2011-12 this week is difficult to answer.

After raising the interest rates ten times since March, 2010, the Reserve Bank of India is likely to raise the rates further by another 25 basis points according to market expectations.

Double digit growth

While the double digit growth (10 to 12 per cent) remains a dream, a sharp decline in growth is also ruled out. This will provide a cushion for the central bank while announcing measures to quill the inflationary pressures. The real threat comes from the global economic situation which is still muddied with debt traps and debt crises.

Even though the growth rates are expected to continue somewhere near 8 per cent, there are many concerns — the most disappointing industrial output and manufacturing data, released recently, in the last nine months; slowing down demand in the economy as evident in car sales reported recently; and slackening loan demand.

Credit offtake

After strong credit growth in 2010-11, the incremental credit offtake has started showing signs of moderation with the year-to-date credit offtake up to July 1 of only 3.42 per cent, said a study by ICRA Research.

The incremental credit growth registered by banks was Rs.1.32 lakh crore in the first quarter of 2011-12, lower than Rs.1.56 lakh crore registered in the first quarter of 2010-11.

However, the latter was boosted by funding requirements for the telecom sector related to the auction of 3G/BWA spectrum held in June, 2010.

Empirical data suggest that credit growth in the first quarter of this fiscal was led by funding of corporates' working capital requirements rather than fresh investments.

While credit growth tends to be sluggish in the first quarter of each financial year and picks up in the second half, the prevailing high interest rates and an expected moderation in economic growth are expected to dampen the pace of credit growth in the current financial year as compared to 2010-11.

The sectoral credit data released by the RBI indicate that while credit to industry and services was buoyant, agricultural credit (12.8 per cent year-on-year) and retail lending (17.7 per cent) lagged overall credit growth in the first quarter of the current fiscal..

Within industry and services, a large chunk of incremental credit in the current fiscal (year-to-date) has been absorbed by infrastructure (particularly power and roads), petroleum and metals sectors.

The medium and large corporate sectors, which grew by 39 per cent and 28 per cent, respectively, continue to attract a greater share of bank funding as compared to small corporates, which registered a modest growth of 13 per cent in the same period.

While the RBI has persisted with monetary tightening since March, 2010, to dampen inflation, several advanced economies continue to maintain a soft monetary stance. Interest rate differentials are expected to persist in the coming months and Indian corporate entities are likely to continue to take advantage of the same and fulfil a part of their funding requirements through ECBs/FCCBs. The RBI recently permitted re-financing through the ECB route to redeem maturing FCCBs, a major driver for ECB issuances in the coming months. While ECB flows are likely to increase, ICRA Research said FCCB flows were likely to be volatile and dependent on equity capital markets in the next few quarters.

Focus on inflation

Maintaining its focus on containing headline inflation, which averaged 9.6 per cent in 2010-11 and 9.4 per cent in the first quarter of the current fiscal, the RBI hiked the benchmark repo rate by 75 basis points in two stages to 7.50 per cent in the current fiscal till June end.

With this, the RBI has cumulatively increased the repo rate by 325 basis points since the unwinding of liquidity measures began in 2009-10. The transmission of the same to bank credit and deposit rates effectively began in the third quarter of the last fiscal and the interest rate scenario has hardened since then with banks increasing their base rates by nearly 100-175 basis points in calendar year 2011, while deposit rates have increased by 100-175 basis points over the same period.

Although overall IIP growth and consumption demand have displayed signs of weakening since April and the impact of policy rate hikes throughout 2010-11 and in the first quarter of 2011-12 continues to percolate into the system, with inflation likely to remain in excess of 9 per cent in the second quarter of this fiscal, ICRA expects the RBI to increase the repo rate by a further 50 basis points in the coming months to dampen inflationary expectations.

Primary food inflation declined to 8.4 per cent in June from 11 per cent in February. However, manufactured food inflation has risen sharply to 8.5 per cent in June from 0.0 per cent in February.

The second stage forecast of the Indian Meteorological Depart- ment in June projected monsoon rainfall at 95 per cent of the long period average (LPA) in 2011. Favourable rainfall in the north western region in conjunction with the considerable available stocks suggests that inflation related to cereals is likely to remain moderate, even as lower-than-average rainfall so far in the central and southern regions may exert pressure on the prices of pulses and oilseeds. Prices of non-vegetarian protein items are likely to remain rigid as a sizable augmentation of supply is unlikely in the short-term.

Moreover, food prices may record a rise in the coming weeks on account of higher transport costs following the revision in diesel prices.

Further, inflation related to non-food manufactured products remains elevated and continuing volatility in commodity prices may cause core inflation to rise in the coming months. Overall, Wholesale Price Index (WPI) inflation is expected to remain above 9 per cent in the first half of this fiscal and may surpass 10 per cent in some months.

Accordingly, the RBI is unlikely to pause in the rate tightening cycle at present.


Though the double digit growth (10 to 12 per cent) remains a dream, a sharp decline in growth is also ruled out. This will provide a cushion for the central bank while announcing measures to quill the inflationary pressures.

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