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The Reserve Bank of India (RBI) hiked its repo rate, at which it lends to banks, by 25 bps to 7.5%, in line with expectations, with the immediate effect. However, this was the tenth rate hike in last 15 month leading to cumulative increase of 250 bps for repo rate. Consequent to the increase in repo rate, the reverse repo rate under the LAF will stand automatically adjusted to 6.5% and the marginal standing facility (MSF) rate to 8.5% with immediate effect. RBI stated that inflation persists at uncomfortable levels. RBI also cautioned that the headline numbers understate the pressures because domestic fuel prices have yet to reflect global crude oil prices. On the growth front, RBI said that even as signs of moderation are visible in some sectors, broad indicators of activity – 2010-11 fourth quarter profit growth and margins and credit growth do not suggest a sharp or broad-based deceleration. The RBI has left its baseline projection unchanged for both growth (around 8% y-o-y in FY12) and inflation (6% with an upward bias by March 2012).
As per RBI, domestic inflation risks remain high, notwithstanding both signs of moderation in commodity prices and some deceleration in growth. Against this backdrop, RBI has indicated to firmly continue anti-inflationary monetary policy stance, recognizing some short-run deceleration in growth may be unavoidable in bringing inflation under control.
Overall, even as there is deceleration in some important sectors, notably interest-sensitive ones such as automobiles, RBI states that there is no evidence of any sharp or broad-based slowdown. Corporate earnings growth and profit margins in the fourth quarter of 2010-11 were broadly in line with the performance over the past three quarters, suggesting that demand remained steady, and in the face of sharp increases in input costs, pricing power remained intact. Credit grew steadily, while the composite Purchasing Managers' Index (PMI) for May 2011 suggests reasonably good conditions.
The domestic growth outlook as indicated in the Annual Monetary Statement of May 3 remains unchanged. However, given the high degree of integration with the global economy, recent global macroeconomic developments pose some risks to domestic growth. Domestic inflation remains high and much above the comfort zone of the Reserve Bank. Particularly, non-food manufactured products inflation rose in May 2011 after showing some moderation in April 2011. Domestic fuel prices do not yet reflect the current trends of global prices. Although global commodity prices moderated in recent weeks, it is too early to downgrade this as a risk factor. Monetary transmission has strengthened. The impact of the Reserve Bank's recent monetary policy actions is still unfolding. The challenge of containing inflation and anchoring inflation expectations persists. Thus, while the Reserve Bank needs to continue with its anti-inflationary stance, the extent of policy action needs to balance the adverse movements in inflation with recent global developments and their likely impact on the domestic growth trajectory.
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