India’s central bank has upped its campaign against inflation, raising rates by half a percentage point, twice previous rate rises. This is the first half point rate rise since 2008 (see chart).
The move comes despite “signs of moderating growth” in the economy, which shows how worried the Bank is about inflation. Strong consumer demand in the country has aggravated the global issue of rising commodity prices, adding to domestic inflationary pressures. That strong demand, in turn, has probably been encouraged by relatively low rates. Indeed, according to the Bank:
…demand has been strong enough to allow significant pass-through of input price increases. Importantly, this is happening even as there are visible signs of moderating growth, particularly in capital goods production and investment spending, suggesting that cumulative monetary actions are beginning to have an impact on demand [emphasis ours]
High and rising inflation has prompted a quarter point rate rise from the Reserve Bank of India, effective immediately. The move was largely expected. Both the repo and reverse repo rates are affected, now standing at 6.75 and 5.75 per cent, respectively.
Annual inflation rose to 8.31 per cent in February, against a target of 4-4.5 per cent. “The underlying inflationary pressures have accentuated, even as risks to growth are emerging,” said the Bank in a statement. “Risks to inflation remain clearly on the upside.”
In addition to food and energy related price pressure, inflationary risks are heightened by growing demand.
India’s Reserve Bank has raised rates to tackle inflation, while extending bank liquidity measures due to expire next week. The repo and reverse repo rates stand 25bp higher at 6.5 and 5.5 per cent, respectively, while easing measures are extended to April 8.
The rate rise was prompted by recent price rises. “Inflationary tendencies are clearly visible,” said governor Duvvuri Subbarao in the statement. “Inflation is the dominant concern… the reversal in [its] direction is striking.” The strength of his words make a 25bp rate rise seem insignificant.
But given global inflationary pressures from food and fuel, India’s December figure was not so dramatic. Viewed historically, annual wholesale price rises of 8.4 per cent still fit into the downward trend seen since April of last year, when inflation was running at 11 per cent. It is too early to say whether December’s figure is the start of a sharp increase in inflation – and today’s decision should make that a little less likely.
Despite the tightening measure, the RBI also announced today that it would alter and extend easing measures
Markets anticipate further easing from the Reserve Bank of India. Twelve-year bond prices are climbing, apparently on speculation that the central bank will intervene to buy the securities to ease the cash crunch facing banks. Bloomberg reports:
The yield on the most-traded 2022 note fell after the Reserve Bank of India last week bought bonds through an open- market auction for the first time since September 2009. The central bank on Nov. 4 bought back 83.5 billion rupees ($1.9 billion) of debt, after offering to purchase as much as 120 billion rupees.
Temporary measures designed to ease a cash crunch in the banking sector over the weekend have been extended to run till Thursday. Additional liquidity will be provided to banks through an extra daily auction, since the Bank’s “liquidity adjustment facility window … has been in … deficit … recent[ly]“. Extra auctions were initially set for October 29, 30 and November 1. Now, auctions will also take place on November 2, 3 and 4.
Banks can also avail themselves of a temporary reduction in the statutory liquidity ratio: they will be allowed to hold 24 per cent rather than 25 per cent with the central bank. By one estimate, this small reduction is equivalent to an additional $10bn liquidity.
India’s Bank rate, standing facilities and Liquidity Adjustment Facility – in short, the key tools the Bank uses to transmit its policy decisions to the real economy – are to be examined and compared with processes at major central banks by a special team at the RBI. Suggestions for changes are expected in three months’ time from the newly constituted Working Group on Operating Procedure of Monetary Policy, the Bank said.
The system of daily auctions, which absorb or inject liquidity – the Liquidity Adjustment Facility, or LAF – will come under particular scrutiny. Here there are no sacred cows: the group will examine the frequency and timing of auctions; the maturity period of the repos and reverse repos used to inject/absorb liquidity; and the size of the gap between the repo and reverse repo rates (the “corridor”). Indeed, the group should consider whether there should be a corridor at all. If so, it should consider whether its width be fixed or variable; and how to optimise its efficiency.
Portfolios have been rearranged among deputy governors at the RBI. India’s central bank made the announcement late yesterday, giving little explanation. In particular, key changes have been made to the remit of deputy governor Dr K C Chakrabarty. The Times of India reports:
Departments like rural and urban cooperative banks have been re-allocated to Usha Thorat while departments of payments and settlement systems have been given to Shyamala Gopinath. Department of administration & personnel management, including works related to Right to Information Act, will be under Subir Gokarn. All these departments were earlier under Chakrabarty.
As part of the ‘calibrated exit’ from expansionary monetary policy, the Reserve Bank of India unexpectedly increased the repo rate to 5.5 per cent and the reverse repo rate to 4.0 per cent. The central bank also extended liquidity support already in place for commercial banks:
i) The additional liquidity support to scheduled commercial banks under the LAF to the extent of up to 0.5 per cent of their net demand and time liabilities (NDTL) currently set to expire on July 2, 2010 is now extended up to July 16, 2010. For any shortfall in maintenance of statutory liquidity ratio (SLR) arising out of availment of this facility, banks may seek waiver of penal interest purely as an ad hoc measure.
The Reserve Bank of India has raised rates for the second consecutive month, but by less than some economists had forecast. The repo rate now stands at 5.25 per cent and the reverse repo is up to 3.75 per cent: both changes are immediate. The central bank has also increased the amount of cash its banks have to hold with the central bank, relative to deposits – its cash reserve ratio – by 25bp to 6 per cent. This will be effective April 24. The last rise was a month ago, a 25bp increase decided at an unscheduled meeting of the board. High inflation is the main motivation behind the rises.
Should central banks persist with inflation-targeting? “The crisis has given fresh impetus to the ‘new environment hypothesis’ that pure inflation targeting is inadvisable and that the mandate of central banks should extend beyond just price stability,” Dr Duvvuri Subbarao said today.
The Indian central bank governor argues that price stability does not ensure financial stability. In fact, he says, there is a trade-off between the two, and “the more successful a central bank is with price stability, the more likely it is to imperil financial stability.”