The RBI will not hike rates in its mid term policy review on the 16th of September 2011. The reason that they will not hike rates is the case of another rate hike at this juncture is just not there. The primary indicators of liquidity, industrial growth, deposit and credit growth and portfolio flows are all down and look to be trending further down. Inflation is the only issue facing the RBI and this has been factored in previous RBI rate hikes. Domestic factors coupled with turmoil in global economies make an extremely weak case for a rate hike.
The primary factors that RBI tracks in framing policy are all pointing to effects of previous rate hikes and global economic turmoil. Liquidity has consistently been on the negative territory with the system borrowing around Rs 50,000 crores on a daily average since the last policy review in July 2011. Industrial growth for the April-July 2011 period at 5.8% is 200bps lower than the growth seen in the same period in 2010. Deposit growth and credit growth at 18.4% and 20.2% year on year is playing out as per RBI’s expectations as the ICDR (Incremental Credit Deposit Ratio) for the period 8th April to 20th August 2011 is at 48% levels, down from an unsustainable 100% levels seen in March 2011. Credit growth has trended down from levels of 22% seen in April 2011 to current levels of 20.2% and given tight liquidity conditions and high rates of interest outlook for credit growth is not positive. Portfolio flows into equity markets, which are considered, as hot money by the RBI is just around USD 250 million and in no ways a threat to inflation.
The rate hikes of the RBI which has taken up the repo rate by 325bps from 4.75% to 8% over the last twenty four months has increased cost of borrowing in the economy by 250bps to 350bps depending on the entity. Banks cost of borrowing has moved up by 250bps while cost of borrowing for lower rated entities have increased by 350bps over the last one year. The high cost of borrowing will filter down into lowering aggregate demand in the economy as it comes on top of higher prices. Inflation has averaged 9.6% for 2010-11 the highest seen in the last ten years and investment projects do not become viable with higher costs plus higher interest rates.
Inflation at 9.78% for the month of August came in higher than expected. Market expectations were 9.6%. However, inflation levels of around 9.5% to 10% is is factored in by the RBI in framing its policy. The conditions for inflation to shoot up from here are not apparent given that monsoons have been good and commodity prices have been steady. The Reuters CRB that tracks a basket of commodities including oil, metals and agriculture is down by 2% since July 2011. The outlook for commodity prices is weak given downward revisions in global growth forecasts due to the debt and unemployment issues facing the developed world.