RBI’s super hawkish monetary policy Q1 2011-12

RBI shocked most market participants by upping the policy rates by 50 bps to 8% in its first quarter review of mon pol 2011-12. Barring very few, most expected a hike of 25 bps in this policy and then may be another 25 bps hike in Oct-11 policy. People expected RBI to pause in Sep-11 review.

People are saying RBI has front loaded of all future rate hikes in this policy and may be no more in future. However, on my reading the Governor’s statement there is no real hint of any pause anytime soon. The statement remains highly hawkish and vigilant on  inflation.

RBI uses some strong language to reinforce its committment to fighting inflation and restore credibility:

It is expected that these policy actions will:

  • reinforce the cumulative impact of past actions on demand;
  • maintain the credibility of the commitment of monetary policy to controlling inflation, thereby keeping medium-term inflation expectations anchored; and
  • reinforce the point that in the absence of complementary policy responses on both demand and supply sides, stronger monetary policy actions are required.

I have not seen RBI use this language before. But this was needed as market participants were feeling because growth has slowed down, RBI might pause etc. But this is not what RBI intents. It does mention growth concerns but just reports them as figures. It also says some indicators show slowdown but those are interest rate sensitive and hence expected to decline. Other variables like exports etc are still robust:

there are signs that growth is beginning to moderate, particularly in respect of some interest sensitive sectors. However, there is no evidence of a sharp or broad-based slowdown as yet. Several indicators such as exports and imports, indirect tax collections, corporate sales and earnings and demand for bank credit suggest that demand is moderating, but only gradually. As such demand side inflationary pressures continue to prevail. Although the impact of past monetary policy actions is still getting transmitted, considering the overall growth and inflation scenario, there is a need to persevere with the anti-inflationary stance.

It maintains inflation is and remains the most important concern:

Inflation continues to be the dominant macroeconomic concern. The headline WPI inflation rate was 9.7 per cent in April 2011. The provisional inflation figure was 9.1 per cent in May 2011 and 9.4 per cent in June. Given the recent pattern, these numbers are likely to be revised upwards. Thus, the headline WPI inflation rate for Q1 of 2011-12 remained stubbornly close to double digits and inflationary pressures continued to remain broad-based. Both the level and the persistence of WPI inflation are a cause for concern.

Non-food manufactured products inflation was 7.0 per cent in April 2011. According to provisional data, it rose to 7.3 per cent in May and remained high at 7.2 per cent in June. This should be seen in comparison with the average non-food manufactured product inflation of 4 per cent over the last six years. The persistence of  high  non-food manufactured products inflation suggests that producers, operating at high levels of capacity utilisation, are able to pass on rising commodity input prices and wage costs to consumers. Early corporate results for Q1 of 2011-12 suggest some moderation in margins. However, such moderation so far has been modest, implying that pricing power persists.

It has increased inflation forecast for Mar-11 from 6% to 7%. That is pretty prompt again. After underestimating inflation for most of 2010-11, it is now serious about inflation projections. Having said that, most expect inflation around 7-7.5% for Mar-11. Revision by RBI might just lead people to revise it further..

There are some risks to inflation outlook as well –

  • Performance of monsoons
  • Crude oil outlook uncertain
  • Element of suppressed inflation via subsidies
  • Administered prices in the WPI basket which could be raised as well like coal

It has even lowered growth projections for money supply and credit. Overall, RBI projections for Mar-11 are:

  Apr-11 Jul-11
Growth 8% 8%
Inflation 6% 7%
M3 16 15.5
Non-food Credit 19 18

Risks to its outlook are:

  • Global commodity prices and their impact
  • Financing of current account deficit. Mentions some shift towards FDI has taken. To be maintained
  • Food inflation depends on global commodities and monsoons
  • Fiscal Deficit remains a concern as subsidy burden likely to overshoot targets. This could impact inflation as well.

The policy stance is same barring an important change. It adds manage the risk of growth falling significantly below trend. So, once again hints growth issues concerns but inflation remains a priority.

Its policy guidance says:

Going forward, the monetary policy stance will depend on the evolving inflation trajectory, which, in turn, will  be determined by trends in domestic growth and global commodity prices. A change in stance will be motivated by signs of a sustainable downturn in inflation.

Overall, a shocker of a policy reaction from RBI. It would please a central banker/monetary economist but is obviously not going to be liked by market participants. Look for an inflation trend that shows sustainable downturn. As of now, it looks far away.

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