RBI may hike repo rate by 25 bps to counter WPI: Experts

At a glance, the higher September WPI at 6.46 percent against 6.1 percent month on month seems more like a food impact, which should not affect core inflation, says Ananth Narayan of Standard Chartered Bank. He feels RBI may now look at hiking repo rate in the 7.75-8.75 percent range in its October policy meet. According to him, it would be a good time for RBI to build up a war chest on the forex side. He does not think RBI's priority is to bring down 10-year bond yields when inflation is still high.

Also Read: September WPI inflation at 6.46% Vs 6.1% (MoM)
He sees the WPI going above 7 percent if the long awaited fuel price adjustment does go through. He feels RBI may consider more rate hikes even after the October policy particularly as data evolves.
Sajjid Chinoy of JPMorgan on the other hand feels the situation is worse than it looks. He feels the pick-up is really from two sources, the first is core inflation and the other is non-food - primary articles and minerals. This in turn suggests it is the impact of the weaker currency on input costs and higher output prices to core inflation.
However, Dipan Mehta, member BSE, NSE, does not think the inflation number will hurt the current bull run. Though it may dampen the enthusiasm a bit, he adds.
Soumya Kanti Ghosh, Chief Economic Adviser, SBI feels there could be a possibility of 25 basis points hike in the repo rate in the forthcoming monetary policy on October 20 and possibly a further decline in the marginal standing facility (MSF) which could be 50 bps. Though he feels if elections are held next year there could be a possibility of food prices tapering December onwards. Below is the verbatim transcript of Ananth Narayan, Sajjid Chinoy, Dipan Mehta & Soumya Kanti Ghosh's interview on CNBC-TV18 Ananth Narayan Q: September WPI higher at 6.46 percent, will markets pencil in more rate hikes? Narayan: I guess it will. To be honest at first glance it looks again a food impact which frankly should not impact core inflation. Having said that the reality is the Reserve Bank of India (RBI) will be cautious here. One does look at a more 7.75-8.75 percent kind of policy coming up in the October. I think it would be a good time for the RBI to build up a war chest both on the Fx side and on the monetary policy side.
I don't think they would want 10 year yields to come down too much at this point in time when the longer term issues are still there in terms of growth being low, fiscal deficit being a potential issue going forward and banking balance sheets looking a little iffy. So yes the market will start factoring in a harder monetary policy, but I think the actual guiding point for RBI would be looking at what the medium term outlook is than just this particular print. Q: Yields have jumped up to 8.58 percent, 10 bps increase in yields, what is your sense about what are they penciling in and how will they move hereon? Narayan: The trajectory for WPI doesn’t look too good now. Infact we see it from a quick calculation going above 7 percent particularly if the long awaited fuel price adjustment does go through. Consumer price index (CPI) should probably not follow suit, it should be milder compared to the WPI move.
Having said that the headline inflation is likely to move up from here and the reality is on the fiscal side there will be several questions being asked and I don't think it is the intension of the RBI to allow too much of bullishness on bond yields, the longer end of the curve. So to that extent I think the 10 year bond yields will be in the 8.5-8.75 percent range. It will be cautious going forward and a steep yield curve looks like being here for sometime.
We could see the RBI considering more rate hikes even after the October policy particularly as data evolves. If there are issues on the fiscal side, if there are issues on the Fx side given the run-up to the elections etc so this could be a time for the RBI to build a war chest and a slightly hawkish monetary policy could be a part of that. Sajjid Chinoy Q: September WPI higher at 6.46 percent, where does this leave your expectations from the RBI? Chinoy: This is worse than it looks because the food number is correct and on a seasonally adjusted basis it is just 40 bps, 0.4 percent month on month. So the pick up is really from two sources, the first is core inflation. I know the year on year number looks low at 2.1 percent, the month on month number seasonally adjusted is 0.5 percent which is annualized at 6 percent so really it is a pickup in core inflation. The other source has been non-food primary articles and minerals. So again that suggests that it is the impact of the weaker currency on input costs and higher output prices to core inflation. So even though the headline number is sobering enough, the components make me more worried this month than they were last month. Q: Would you really annualize 0.5 percent, I mean there is the impact of rupee depreciation and as you said growth sets in disinflationary forces. One should not runaway with expectations that core inflation has really picked up, it could be a one time adjustment. Chinoy: True. The issue is for three successive months you have now seen positive increases compared to negative increases the previous three months so on a three month by three month basis the momentum of core inflation has picked up that is the best we can say. And the issue here is in an environment where growth is weak but input costs are still rising whether it is fuel or currency, whether firms pass that on and the only point is this month they have passed that on. Dipan Mehta Q: We saw the Nifty lose all its gains and get into a bit of negative terrain – will this inflation number hurt the current bull run very severely? Mehta: I do not think so but to an extent it does dampen the enthusiasm behind interest rate sensitive and banks in particular. That was a segment which was getting a bit energized since morning after the statements came from the RBI Governor that they could be and the finance minister that there could be some reforms in the financial services and banks as well. To that extent one needs to scale back on banks and interest rates sensitives because this tight monetary policy may continue for some more time but then the market has a lot of choice and we are really seeing that the exporters led by Tata Consultancy Services (TCS) and other IT companies are in a zone by themselves and they are not going to be impacted by the numbers per se.
I would say that the headline index would continue to struggle on pretty much well. In any case banks are getting lesser weightage in the indices and in investors portfolio- so, it is not a positive development but it is not a game changer as well. Soumya Kanti Ghosh Q: Your thoughts, you think a rate hike is given in October and more will come? Ghosh: I believe that there could be a possibility of 25 basis points in the repo rate in the forthcoming monetary policy and possibly the decline in the marginal standing facility (MSF) which I believe that it could have been 50 bps in the October 20 monetary policy may now be delayed little further.
So we could be actually at 25 bps and then after this FCNR (B) window is over, we can get onto that 100 bps corridor. However, the most important point is that if you look at the data, primarily if I talk about the two numbers, the first is the core numbers which has increased to 2.1 percent this month. There has been an increase but I believe we are still not significant enough to suggest that the significant pass-through of the corporates purchasing power, there has been a marginal increase but what worries me now is the rapid increase in the food prices and here there is an interesting trend.
There has been a lot of discussion about agricultural growth this year which could accelerate to now more than 5 percent as a lot of people believe. In FY06 when we had an agricultural growth it was at 5.1 percent, we had a food inflation, which was very manageable and I think it was below 5 percent.
However, that trend of higher agricultural output growth and a lower food inflation was broken from FY08 onwards and in FY09 even after the agricultural and allied activities grew at 7.9 percent, we had an ugly food inflation number in excess of 15 percent, 15.6 percent to be more precise. So my worry is that even if you log in a significantly good number on the agricultural front, the food price may not abate in the coming months. Q: What are you expecting by way of rate hikes, only one in October, not more you think? Ghosh: I expect one in October because I have a perception that the one possible game changer could be elections because if you look at the last time trend there was a rapid increase in food prices prior to 2009 election and that has declined rapidly also till March 2009, then it witnessed a pickup. So from that point of view that is the one consideration you need to take into account because if elections are held next year there could be a possibility of food prices tapering December onwards.