International Markets

Reserve Bank of India to leave interest rates on hold for now

The Reserve Bank of India (RBI) is due to meet on Tuesday 24th in the wake of increasing evidence that inflation is now past its peak. The headline, and most closely watched, WPI measure of inflation decelerated in December to just short of 7.5% (annual rate) from more than 9% in November. On a month on month comparison, the inflation index actually rose (by 0.5%) so the decline in the annual rate was a direct result of helpful base effects; last December vegetable prices rose particularly sharply. Nevertheless, the underlying picture is clearly moderating which will be welcome news for the authorities. That said, we are inclined to believe that the RBI will choose to leave interest rates on hold for the time being. Expectations for economic growth have been revised downwards in recent months with the FY2012 outturn now likely to come in around 7.3%. However, the tone of recently released sentiment surveys has been a little more upbeat with the manufacturing PMI index, most notably, climbing to a six month high.

The RBI has already conducted another open market operation in the early weeks of the New Year, purchasing INR 120bn of government securities. This is the seventh round of such activity over the past couple of months. Critically, this action should not be interpreted as an easing in policy. Rather, it is very clearly an attempt to prevent an unintended tightening in liquidity which has been visible in the interbank rate hugging, and at times breaching, the upper end of the existing policy band. Further measures to address this issue are probable during the first quarter as the stress in the market persists in the face of slowing capital inflows and a current account deficit.

The impact of previous rounds of monetary tightening does appear increasingly apparent in the take-up of credit. Growth in loan demand has slowed to an annual rate of 17% from an average of 22% in the first half of 2011. More specifically, the equivalent numbers for housing related loans are 13.8% and 16%. This more moderate trend in mortgage finance is consistent with some anecdotal reports of lower levels of residential sales activity.

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