RBI may have almost done with rate tweaks.

MUMBAI: The surprise in the Reserve Bank of India’s mid-quarter policy review was not the hike, but the central bank’s observation that following the hike, policy rates were close to equilibrium. The central bank has also said its attempt to end negative real interest rates are working but the process is still incomplete.

After the policy statement, many now believe that RBI is nearly at the end of the road as far as planned tightening is concerned. Going forward, any policy measures are expected to be in response to developing macro-economic concerns rather than a part of a calibrated move.

In its statement, the central bank said: “RBI believes that the tightening that has been carried out over this period (since October 2009) has taken the monetary situation close to normal. The role of normalisation as a motivation for further actions is likely to be less important.”

Going forward, the prevailing and the expected macro-economic conditions will be more important considerations in the monetary policy formulation.

“We believe RBI has finished raising the repo rate, but has left a small window open for further action on the reverse-repo rate, especially given the priority of narrowing the corridor,” said Barclays Capital Research economist Rahul Bajoria.

The central bank has hiked its repo and the reverse repo rates — the rate at which it lends to banks and absorbs surplus liquidity — by 25 bps to 6% and 50 bps to 5%, respectively. “The asymmetric hike in rates narrows the LAF (liquidity adjustment facility) corridor to 100 bps (similar to the situation prevailing in the early/mid 2000s) and will likely reduce the volatility in overnight rates,” said Citi group India economist Rohini Malkani, in a note to clients.

Moving towards the best practices adopted by major central banks, RBI for the first time has come out with a mid-quarter review of the monetary policy in the form of a brief note to the media. This move comes almost after five years since it started a system of quarterly review of the monetary policy from July 2005 onwards.

RBI in its statement appears more optimistic about the growth momentum. Though RBI has expressed it reservations about the volatility in the data on industrial output, it is very optimistic about the growth prospects for agriculture which been boosted by the monsoon. Moreover, almost all leading indicators of service sector activity point towards sustained growth.

Its concerns about poor transmission mechanism of the monetary policy measures have receded with 40 banks raising deposit rates and 26 their lending rates since the central bank has started tightening rates. This process is expected to continue, which in turn will render the repo rate as an effective rate.

It is also not worried about the government overshooting its fiscal deficit target of 5.5% (of GDP) even after taking into account the supplementary demand for grants. This optimism is based on higher than expected realisations on 3G and broadband wireless access (BWA) auctions combined with buoyant tax revenues. “This will help stabilise market expectations of liquidity and interest rate movements,” the central bank has said in its statement.

Moreover, capital flows are returning to emerging market economies, including India. If this trend continues, the risks on the external front may recede despite exports remaining sluggish.

Source : economictimes.indiatimes.com