India, it seems, is destined for stubborn inflation and repo rate hike. On January 28, the Reserve Bank of India (RBI) unexpectedly hiked its repo rate by 25 bps to 8% in a bid to contain inflation. With the latest hike, India raised its repo rates by the same amount three times in the past five months.
The Indian economy has been a victim of slowing economic growth, persistent sky-high inflation, huge current account deficit, lower per-capita income and massive corruption. After a roller-coaster ride in much of 2013 on the Fed’s taper concerns and falling currency (down about 14% in 2013), concerns over the Indian market have been mounting since the beginning of this year thanks to the Fed’s decision to start scaling back its QE program.
Investors should note that India’s inflation rate at more-or-less 10% is presently one of the highest in Asia. With a possibility of continued QE trimming and flight of foreign investments from the nation, Indian currency – rupee – is likely to weaken further in the coming days and stir up another round of inflationary pressure. While a slowing in December inflation has already been recognized, rising pressure in service sectors and wage-led stress on inflation were responsible for the RBI’s anxiety.
This apprehension might have prompted RBI to go for another rate hike since its goal – and the principal agenda in its to-do list–is to pull down inflation to 6% by 2016.
Further Tightening Ahead?
Economists expect the RBI to clamp down on liquidity in the coming months as reduction of 4% inflation within two years apparently seems a tall order for India. Some economists anticipate yet another 25 bps hike in rate in early summer. However, the RBI commented that there will be no further tightening in the near term if consumer-price inflation slackens from the high of 10% to 8% by early 2015.
However, many economists seem content with the latest RBI move which is aimed at shoring up the Indian economy over the long term and serves in ruling out inflationary threats and currency depreciation. Still, there are economists with the opposite view as well. As per the CII, the RBI needs to focus on boosting investments and economic growth instead of curbing inflation (see Is the Worst Over for These Emerging Market ETFs?).
Yes, this step surely comes at the cost of growth (via higher cost of borrowings) and probably corporate defaults. As per India Ratings, the number of stressed companies will increase to 10.7% from the current 9.5% if this latest rate hike results into higher lending rates.
In fact, the situation may worsen if the RBI goes for further hikes this year by taking the number of stressed corporates to 13.1% and the amount of stressed debt to 16.5%. With the World Bank expecting Indian growth rate below 5% – a 10-year low – for the financial year 2013–2014, the recent hike is upsetting.