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High inflation rates to persist over the next few months
Aug '08
Although the increase in the repo rate by 50 bps was unexpected, the firmness of its anti-inflationary stance sends a strong signal to the markets that the Reserve Bank of India (RBI) sees spiralling inflation as a far greater threat than slowing growth.

Coming soon after a similar move last month, Tuesday's announcement leaves no one in any doubt about the central bank's determination to bring the rate of inflation down as quickly as possible.

While the measures will have an adverse impact on demand through higher interest rates, which are bound to increase, given the tight liquidity conditions, the threat that rising inflationary expectations poses to medium-term growth performance is real and justifies the aggressive anti-inflationary stance taken by the RBI, even if it comes at some cost in the form of slower growth in the immediate future.

Dr. Subir Gokarn, Chief Economist, Standard & Poor's Asia Pacific, said: “We have to accept the fact that a trade-off between growth and inflation in the current circumstances is inevitable.

Despite the clear signs that growth is slowing, as seen in the recent industrial production numbers, it is far too early for the Reserve Bank of India to move to a neutral position, let alone reverse course.

Even after all that has been done, inflationary pressures may still be aggravated by global developments but, for the moment, the current policy stance is the most appropriate one.”

Mr. Dharmakirti Joshi, Principal Economist, CRISIL, added: “The decision to raise the repo rate by 50 bps rather than the much-anticipated 25 bps was motivated by two factors.

One, the fiscal situation, particularly on account of the loan waiver and the implementation of Pay Commission recommendations, is providing a demand stimulus, which can only intensify the inflationary pressure.

Two, since domestic fuel prices do not fully reflect the global price scenario, energy prices are not helping to reduce demand to the fullest possible extent. This also adds to demand-side inflationary pressures.”

With high inflation rates likely to persist over the next few months, we do expect further tightening in or before the next scheduled announcement at the end of October.

Our current outlook for key macroeconomic indicators for 2008-09 are as follows: GDP growth at 7.8 per cent; average wholesale inflation for the year at 11.5-12 per cent, although this will fall sharply in March 2009; year-end yield on 10-year government securities in the range of 8.8-9 per cent; and, the year-end rupee-dollar exchange rate at Rs.41.5-42/$.

The policy stance will clearly have a negative bearing on the growth outlook for 2009-10, but this is an expected part of the adjustment process, which will help to preserve a favourable medium- term trend.

Credit Rating Information Services of India Limited

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