Saturday, March 20, 2010


KIDS' GLOVES OFF !!!


Taking a tough stance on the spiraling inflation, RBI has announced a surprise hike in its key policy rates – repo and reverse repo –by a quarter percentage point each. This is the first increase in two years and more tightening measures are expected to follow as the central bank gears up to fight inflation. Post-increase, the repo rate stands at 3.5% and reverse repo rate at 5%.

The hike comes one month before the scheduled annual policy review and follows a 75 basis points hike in the cash reserve ratio in January. The rate hike should anchor inflationary expectations and contain inflation going forward, the central bank said. The measure also shows policy makers’ confidence in the momentum of economic recovery. As liquidity in the banking system will remain adequate, credit expansion for sustaining the recovery will not be affected.


While the headline inflation on a year-on-year basis at 9.89% exceeds RBI’s baseline projection of 8.5% for end-March and is within a striking distance of a double-digit score, India’s industrial production gained 16.7% in January following a 17.6% increase in December from a year earlier - the fastest pace in more than a decade. The high inflation was until recently perceived to be on account of supply-side factors. But, the central bank now recognises the rising demand side pressures accentuating and complicating the risk of rising inflation.


It is clear that the focus of monetary policy will now tilt towards containing the inflation and inflationary expectations, rather than worrying about a pre-mature tightening undermining the recovery. The fine print of the RBI statement indicates that the pace of the ‘calibrated exit’ would be accelerated. Please share your views.

  • Will there be another 25 basis points hike in April? My expectation is YES followed by a series of hikes.
  • What will be the level of the policy rates in one year from now (March 2011)? My hunch is at least 150 basis points above the current level.

EXCEPTIONALLY LOW …….. FOR AN EXTENDED PERIOD ……..

America’s Federal Reserve indicated it would be keeping interest rates at close to zero for the foreseeable future, in order to nurture the economic recovery. While the Fed has declared its optimism that the country’s economy was slowly recovering, it decided to maintain the target federal funds rate at the current level of 0-0.25% in view of a mixed picture of the recovery from recession amidst low rates of resource utilization, subdued inflation trends, and stable inflation expectations.


The Fed is widely expected to maintain the current level of interest rates through 2010. However, more significant will be its moves on withdrawal of the liquidity stimulus programmes running into hundreds of billions of dollars that have been in force since the beginning of the sub-prime crisis – the pace and timing of the unwinding. Also, when it is going to drop the four magic words from its statements – ‘exceptionally low’, ‘extended period’.