Rate hikes loom despite sub-8% growth concern

Even as it is becoming increasingly possible that the economy may clock sub-8% GDP growth in 2011-12, the Reserve Bank of India (RBI) has little choice but to increase policy rates when it meets later this week. With inflation averaging 8% and expected to come down just a tad lower at 7.8% in February from 8.2% in January, the rise in prices is way above the central bank's revised projection of 7% for March 2011. As such, key policy rates are tipped to be hiked by 25 basis points each taking the repo rate to 6.75% and the reverse repo to 5.75%, in what would be the eighth increase in a year.  Earlier this month, China upped its benchmark one-year lending rate to 6.06, the third increase since mid-October after growth accelerated and inflation stayed above 4% for a third month.  With crude oil prices have risen nearly 20% in the last three weeks in the wake of the unrest in West Asia, South, Korea, Thailand and Vietnam have all raised borrowing costs this month. Fund managers, however, believe central banks in many of the emerging economies are behind the curve in terms of taming inflation and more than $20 billion has moved out of emerging market funds since the start of the year.  According to Bank of America-Merrill Lynch, the central bank could tighten money by 75 basis points through the year. Indeed, while a high base effect will help cushion the wholesale inflation number till July, 2011, average inflation for 2011-12 is likely to be fairly high at 6.57%.Core non-food inflation is tipped to remain sticky at 5%, higher coal prices will add to costs while the government may choose to pass on the higher prices of crude oil through a hike in diesel prices.  Monetary transmission couldcontinuetobeasswift as it has been the case in the last couple of months -banks have raised loan rates by at least 50 basis points between early December and now in two tranches. As such, loan rates could climb further. Demand for non-food credit has been growing at just over 20% year-on-year since October, 2010 and given that deposits continue to grow at a far slower pace of 16%, RBI would continue to keep credit growth on a leash so that liquidity remains sufficient. With the gov ernment announcing in its Budget statement that it will borrow a net amount of just R3.4 lakh crore in 201112, the bond markets have rallied smartly; yields on the benchmark bond are ruling at around 8%. However, yields could spike if borrowings overshoot the target.                                        Financial Express