No policy rate hikes likely in 2008

The year 2008 is likely to be free of any policy rate increase, a definite pause for the first time since September 2004, when the current phase of monetary tightening by the Reserve Bank of India (RBI) began.

There is a general consensus that policy rates have peaked and the next rate move will only be a cut in the repo rate. Will a rate cut happen in 2008? That's still uncertain. While some predict a policy rate cut sometime in the second half of calendar year 2008, some say such a step is likely only in 2009.

HSBC has dropped its earlier view that the RBI will raise the policy rate one more time in the second half of 2008. "... it seems to us that the next move in the repo rate is more likely to be down than up, albeit not until 2009. If we are right, and bearing in mind that the last change in the repo rate was announced on March 30, 2007, then the policy pause will last roughly two years," HSBC said in its India report.

An increase in the cash reserve ratio (CRR) is likely as the RBI continues to absorb foreign capital inflows to check the rupee's rapid rise.

Banks are likely to absorb the impact of a CRR hike by adjusting their deposit rates, as there is a risk of a sharper rise in defaults if there is any further increase in lending rates.

The moderation in credit growth is expected to bloat the non-performing assets ratios, which will be further exacerbated by a rise in defaults as a result of loose lending norms followed in times of retail lending boom.

"We maintain the view that policy rates have peaked, but for several reasons do not expect the RBI to cut policy rates at least until the July 2008 quarterly policy meeting. Growth momentum is still strong and risks to inflation persist... Also, cutting rates now could fuel further asset appreciation, especially in the property market, which is already worrying policy makers," said JP Morgan Chase in its India report.

HSBC said uncertainty about the growth outlook was likely to have increased within policy circles. Notwithstanding the bounce in October industrial production, which reflected base effects and which will reverse in November, Indian output growth is trending lower and, according to some business surveys, will continue to do so.

HSBC further said that the ongoing strength of the rupee, together with the collapse in metal price inflation (from 80% in July last year to –3% now) has helped subdue the key WPI rate, which is currently running at 3.75%.

"The weakness of food price inflation has surprised, while the higher crude oil price has yet to be passed on. Looking ahead, and assuming there is some adjustment to the domestic oil basket, headline WPI inflation will probably rise close to 5% by mid-2008. At this time, however, signs of economic weakness may well have taken centre stage. We continue to project just 7% GDP growth in 2007-08 as the factors mentioned above, together with the lagged effects of the higher interest rates and exchange rate, feed through in full," it said.