50 better than 25 - Arjun Parthasarathy

The sharp upswing in March inflation, almost a percentage point over RBI forecasts, deserves a higher quantum of rate hikes. The RBI should raise repo and reverse repo rates by 50bps each as a signal of inflation veering sharply higher than estimates and as a signal of inflation being understated due to government’s fuel subsidy policies. RBI is scheduled to hold their policy meet in May 2011. The market is expecting a 25bps rate hike based on RBI’s wordings in their policy review in March, but will now start factoring in a 50bps hike after the March inflation numbers. A 50bps hike will be accompanied by a more benign inflation forecast as the RBI will then look to see the positive effects of rate hikes on inflation. The 50bps rate hike should then be taken positively by the market, as it decreases uncertainty on surprise hikes or jumps in inflation numbers. The market will also start looking ahead towards the end of rate hikes, which could just be a couple of policy reviews away. In the meanwhile if the government does raise fuel prices, inflation numbers become more reasonable and reflect reality.  The sensex will benefit from a 50bps rate hike as the currency will be under pressure to appreciate bringing in more foreign flows. The RBI is not alone in their anti inflation campaign. China saw inflation for March come in at 5.4% against expectations of 5.2%. China has raised rates twice this year to quell rising inflation expectations. The Yuan has benefitted from the rate hikes and has climbed by 4% over the last one year against the USD and is holding at 15 year highs. The Shanghai composite index has gained around 8% over the last three months, indicating that equity investors are expecting a soft landing for China.  Singapore allowed its currency to appreciate to a record high this week to counter inflation which is running at 5% levels. The Singapore dollar has gained around 10% over the last one year.   Inflation as measured by the WPI (Wholesale Price Index) came in at 8.98% for the month of March 2011 against economists’ consensus expectation of 8.38%. RBI had forecast an inflation rate of 8% for March 2011. The WPI growth was revised to 9.35% from 8.23% for the month of January. The March inflation number does not factor in the sharp rise in oil prices as the government has not raised fuel prices to pass on the oil price rise to the end user. The Indian crude basket price climbed to over USD 110/bbl in March up by 9% over the previous month. Global oil prices are higher by over 30% in the last six months. The government is running up a subsidy bill of over Rs 175,000 crores at current selling prices of fuel. The fuel subsidy is vastly understating inflation and the upside surge in inflation for March does not even remotely reflect the fuel price rise.