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Economy

RBI Ups Rates by 0.25%

The Reserve Bank has increased interest rates by 25 basis points (0.25%) in its review meeting of Jan 2011. The monetary policy document says a lot about RBI’s concerns.

15. However, year-on-year non­food credit growth has been above the Reserve Bank’s indicative projection of 20 per cent since early October 2010, rising to 24 per cent by end-December 2010. The wide gap between credit growth and deposit growth resulted in a sharp increase in the incremental non-food credit-deposit ratio to 102 per cent by end-December 2010, up from 58 per cent in the corresponding period of previous year.

16. Disaggregated data suggest that credit growth, which was earlier driven by the infrastructure sector, is becoming increasingly broad-based across sectors and industries, evidencing growth momentum and demand pressures. Credit flow to the services sector increased significantly for transport operators, tourism, hotel and restaurant and commercial real estate, besides retail housing and personal loans. As regards industry, apart from infrastructure, increase in credit was significant for metals, engineering, textiles, food processing and chemical and chemical products.

Global Outlook

Growth

27. With advanced economies showing firmer signs of sustainable recovery, global growth in 2010 is expected to have been less imbalanced than before. While growth in advanced economies may improve, growth in EMEs, which have been the main engine of global economic growth in the recent period, may moderate due to tightening of monetary policy to address rising inflationary concerns and the waning impact of the fiscal stimulus measures taken in the wake of the global financial crisis.

Inflation

28. Even as a large slack persists, inflation has edged up in major advanced economies owing mainly to increase in food and energy prices. Inflation in the Euro area exceeded the European Central Bank’s (ECB) medium-term target for the first time in more than two years in December 2010. Similarly in the UK, the headline inflation has persisted above the target of the Bank of England. In the US, the headline CPI rose to 1.5 per cent in December 2010 from 1.1 per cent in November 2010. Whereas signs of inflation in the advanced countries are only incipient, many EMEs have been facing strong inflationary pressures, reflecting higher international commodity prices and rising domestic demand pressures.

29. Significantly, food, energy and commodity prices are widely expected to harden during 2011, driven by a combination of supply constraints and rising global demand, as the advanced economies consolidate their recovery. This suggests that inflation could be a global concern in 2011.

Be prepared for a lot of inflation. I wish they sold some of their nearly $300 bn of dollars and cut things down. But no, and it gets worse:

37. The third factor is the extent to which demand side pressures may manifest. This risk arises from three sources, viz., the spill-over of rising food inflation; rising input costs, particularly industrial raw materials and oil; and pressure on wages, both in the formal and informal sectors. The rise in food inflation has not only persisted for more than two years now, the increase has been rather sharp in the recent period. This cannot but have some spill-over effects on generalised inflation, particularly when the growth momentum is strong and both workers and producers are likely to have pricing power. There are indications that, in the corporate sector, the share of wages in total costs is increasing. The indexation of the Mahatma Gandhi National Rural Employment Guarantee Act (MGNREGA) wages will also raise the wage rate in the agricultural sector. Further, besides oil, the prices of some primary non-food articles have risen sharply in the recent period. Since these are inputs into manufactured products, the risk to headline inflation is not only from the increase in non-food items but also because the increase in input costs will ultimately impact output prices. As the output gap closes, corporates will also be able to sustain higher output prices. In the absence of commensurate increase in capacity, there is the risk of demand side pressures accentuating.

There is a lot more. And it’s got inflation written all over it.

0.25% isn’t going to do much. The markets were up nearly 1%, and proceeded to crash, and end DOWN 1%. Banks were the worst hit. The bond markets and interest rate swaps showed the one year rate around 7.5% and 10 year bonds were at 8.2% – nothing much changed there.

  • Ramanand says:

    >0.25% isn't going to do anything! Earlier, RBI used to take an aggressive stance on fighting inflation …that is during YV Reddy's time. At the time, we even allowed the rupee to appreciate against the dollar to about Rs. 39 per dollar! That was of course, before the financial crisis in the US. Subbarao is doing no such thing. RBI (and India in general) is boxed into a corner regarding the Rupee. Letting it appreciate would kill the exporters/IT industry and letting inflation rule would kill the poor/marginal. Either way, inevitable shocks await us and the world economy in general.