RBI googly stumps industry, markets



The key policy rate, or the repo rate, raised 50 bps to 8%.



The smile stayed on Duvvuri Subbarao’s face throughout the day — during the customary meetings with bankers in the morning and with the media in the afternoon. But what the Reserve Bank of India (RBI) governor said at those meetings wiped the smiles off bankers and those representing industry and markets.

• Repo rate increased by 50 basis points;
• Banks may pass on the entire increase to customers;
• RBI says focus will remain on fighting inflation;
• Industry asks RBI to indicate when the cycle will end

A majority of them said immediate lending rate increases were inevitable, making life extra tough for companies and individual borrowers. After stunning everybody by raising the repo rate, the rate at which it lends to banks, by 50 basis points (bps) to 8 per cent, Subbarao hinted at continuation of the rate increase season, catching unawares most economists and market participants, who had expected RBI to signal the end of its tightening spree. Tuesday’s rate increase was 11th since March 2010, making RBI one of the most aggressive inflation fighters among central banks, and sent bond yields and swap rates higher and stocks lower. The Bombay Stock Exchange Sensitive Index fell 353 points, the most in five weeks. RBI in effect debunked the government’s rosy projection of inflation cooling to around 6 per cent by March 2012. It instead raised its projection to 7 per cent, up a sharp 1 percentage point from the May figure. It, however, chose to retain the gross domestic product growth projection at 8 per cent, which surprised many. Jahangir Aziz, chief economist at JP Morgan, wondered how this was possible when RBI had revised the credit growth projection and expressed concerns over the global slowdown. But more than Tuesday’s rate increase, what worried market participants was RBI’s signal that it had no time frame for easing the policy. Announcing the First Quarter Review of the Monetary Policy on Tuesday, Subbarao said, “Considering the overall growth and inflation scenario, there is a need to persevere with the anti-inflationary stance. A change in stance will be motivated only by signs of a sustainable downturn in inflation.” While few were willing to make any prediction given Tuesday’s experience, some said they won’t be surprised if there was another 25 bps increase in the next review on September 16. “We still think the monetary policy is in a neutral gear and policy rates have to go further up to slow growth. Going ahead, we see another 25 bps increase at least,” said Leif Eskesen, chief economist, India & Asean, Hong Kong and Shanghai Banking Corp. Bankers said their response would be quicker this time. While private sector lender YES Bank increased base rate by 50 bps, HDFC Managing Director Aditya Puri said rates would certainly go up, though he refused to say by how much. State Bank of India Chairman Pratip Chaudhuri said the increase would be passed on to customers and deposit rates at the shorter end would increase. All of them agreed that credit growth would be hit, may be more than RBI’s scaled-down figure of 18 per cent. Industry was quick to express displeasure. The Confederation of Indian Industry said the increase was a matter of great concern since there could be a tipping point beyond which coming out of the downward growth spiral could be an arduous task. The chamber pleaded with the governor “to pause and indicate when this tight monetary stance would be eased”. Ficci termed the move a “major disappointment”. Others preferred to be more colourful. Mahindra Group Vice Chairman Anand Mahindra tweeted: “First, the loss of the test match yesterday and then the oversized increase in interest rates on Tuesday. Feels like we have been bowled out twice in two days.” Significantly, RBI said the measures were expected to “reinforce the point that in the absence of complementary policy responses on both demand and supply sides, stronger monetary policy actions are required.” Justifying his decision, Subbarao cited two factors: Strong demand-side pressure, as reflected in more than 7 per cent core inflation, and no evidence of broad-based or sharp economic slowdown, though signs of moderation are evident in some interest rare-sensitive sectors. Subbarao said Tuesday’s action was expected to “maintain the credibility of the commitment of the monetary policy to controlling inflation.” RBI also recognised the fact that banks’ asset quality would be impacted as rates had hardened. However, both banks and RBI said rising non-performing assets did not pose any systemic risk.

BS