Mumbai: Inflation is top on the Reserve Bank of India’s parameters list, despite being below its 2007-08 target of 5% for the last eight months, indicating that the bank may not be comfortable with cutting rates just yet.
 
The RBI’s customary macro economic and monetary development report on Monday, a day before the policy review, reiterated that “inflationary pressures” remain in the economy.

The central bank had set a 5% inflation target for the year in its annual policy review in April 2007. Benchmark inflation (at 3.83% currently) has been below that mark for the last eight months.

The RBI acknowledged that the wholesale price index (WPI) has “remained below 4% since mid-August 2007” thanks to the moderation in prices of primary food articles and some manufactured products, as well as base effects.

But in the same paragraph, the bank hinted that this lower inflation may, in fact, be “suppressed.”
 
“It may, however, be noted that since pass-through of higher international oil prices to domestic prices remains incomplete, inflation has remained suppressed. Elevated international food prices also pose potential inflationary pressures in the period ahead,” the report said.

The bank went on to say that inflation in India was the “fifth highest” among select emerging market economies, strongly hinting that the time to cut interest rates may not have come just yet.

Pressure on the RBI to cut interest rates has increased significantly since the US Federal Reserve cut its target funds rate by a whooping 75 basis points - its largest cut in 20 years - to 3.50% last Tuesday.

The cut has widened the difference between the federal funds rate and the RBI’s repo rate to 4.25%, increasing fears that more foreign money will flow into India to take advantage of the higher interest rates here.

Traders expect a further cut 0.50% in the overnight lending rates when the Fed meets on Tuesday and Wednesday.

However, the RBI’s insistence on inflation pressures means that the tone of the policy may not be as dovish as expected by some analysts. Already, the market is split into half by those expecting a cut and those not.

DSP Merrill Lynch economist Indranil Sen Gupta, says the report indicates the RBI will probably be more aggressive in its policy stance.

“Even if they cut rates it will be marginal, probably 25 basis points repo cut. They will sound hawkish because if they don’t, probably the market will go up like mad and asset prices will rally, which won’t be good in the present situation,” Sen Gupta said.

Sen Gupta said ideally, the central bank should cut the cash reserve ratio, but high money supply of more than 22% (versus RBI target of 17-17.5%) means that is not an option. He predicts a 25 bps cut in the repo rate on Tuesday.

 

Source : Dna