RBI likely to hold rates; inflation may head to 8%: HSBC

Even after a slew of reforms from the government, the Reserve Bank of India is not likely to oblige with a rate cut in its monetary policy review today. Experts believe, the high inflation figures may not lead to an immediate interest rate cut. Leif Eskesen, Chief Economist for India & ASEAN, HSBC also echoes similar sentiments and feels the RBI might hold rates this time as well.

Also read: RBI unlikely to budge yet on rates

Moreover, taking into account the high diesel prices and the impact of a weak monsoon, inflation is likely to shoot up to the 8% mark in the short term, added Eskesen.

Here is the edited transcript of the interview on CNBC-TV18.

Q: What are you expecting from the Reserve Bank today and what kind of tone do you think the Reserve Bank will outline at its policy?

A: The very positive policy measures that came out last week have increased the possibility of a surprise from RBI today, but we still think on balance that it's most likely that they will remain on hold. The reason for that is number one, inflation pressures are still rising and we saw it last week. Part of that was actually driven by core inflation moving up.

The rains are not as deficient as it was earlier during the monsoon season, but nevertheless there is still upside risk to inflation from that front and also the adjustment in diesel prices that are coming up. From the inflation point of view, there are still reasons to be concerned and keep things firm. Also on the policy measures, there still is a possibility of some watering down of these implementation risks although, we do believe on the whole, that they will more or less get through.

But, the risk is there nevertheless. That would also be something that you would need to factor in. On the steps that are taken on the fiscal front so far, the hike in diesel prices will not be enough to contain the fiscal slippage. Even if we are factoring in the rise in diesel prices that was announced last week, we are still looking at a central government deficit of 5.8% in 2012-13 absent further savings measures.

That obviously is far to lose fiscal stance to have at the moment. I think the RBI would also ideally want to look for additional fiscal savings measures before they are comfortable about fiscal policy moving in the right direction and therefore, complimenting monetary policy efforts to keep inflation low.

Q: If your view is that a repo rate cut in these kind of conditions is difficult for the Reserve Bank, do you see any outside possibility of a liquidity measure like a CRR cut this time around?

A: No, even smaller chance for that. The liquidity deficit is back into the comfort zone very easily. So that would be the least likely outcome I would say, no reason to do that really. I think what I would do is clearly recognize the policy measures that have been taken last week and use more verbal guidance on monetary policy, more forward looking guidance, opening the door potentially for rate cuts at the next couple of meetings if these policy measures come through and also if we have some easing off on the inflation side.

I think that would be a good way to balance the inflation risks on the one hand and implementation risk in the short-term with the potential favourable outcome of these policies going ahead if they are implemented as planned.

Q: Given the higher crude prices that we have seen and the diesel price hike, what is your estimate of how much higher inflation could head after the kind of tick that we saw last week?

A: I think if you look at the diesel hike by itself, when you have second order impact factored in it could add around 0.9-1 percentage point to the inflation reading. The second order impact is going to take a few months to filter through, but the initial impact from the hike is going to be 0.6% or thereabouts.

If inflation stays where it is we are going to move up to around 8% in the short-term on the back of this before we start to see inflation pressures coming off. That also has implications for inflation expectations and as I said, you still have the lingering impact of the deficient monsoons that could add to inflation pressures on that side as well.

These are other reasons, from my perspective, why it would make sense to stay on hold today, buy a little bit more time on that side to see whether winds are blowing when it comes to the inflation picture.