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Rising inflation may limit rate cuts in RBI policy

Trade-off between growth & inflation will be a challenging call for RBI . Inflation is facing an uptrend after temporarily moving in a RBI comfort zone of below 7%.

, ET Bureau|
Updated: Jun 15, 2012, 04.32 PM IST
MUMBAI: With the Reserve Bank of India (RBI) policy review slated on Monday, there is widespread expectation among many market participants that the RBI will once again cut policy rates. The banking regulator has surprised the market with a higher-than-expected rate cut of 50 bps in the previous policy meet.

"Market consensus is for a cut in policy rates, citing problems on the growth front, especially after 4QFY12 GDP numbers came in at 5.3%," says Indranil Pan, Chief Economist at Kotak Mahindra Bank.

"Considering the domestic growth-inflation dynamics, euro unrest juxtaposed with near-term drag down in the liquidity stretch, we expect the stance of RBI in the forthcoming policy meet to go for a sentiment smoothing 25 bps repo rate cut," says Shakti Satapathy, Fixed Income Analyst at A.K Capital Services

But the trade-off between growth and inflation will be a challenging call for the RBI this time, expert says. The inflation is steadily facing an uptrend after temporarily moving in a RBI comfort zone of below 7%. The Wholesale Price Index (WPI) for the month of May rose to 7.55% compared to 7.23% in April. The rise came in as both food and fuel prices picked up.

"The higher inflation number does put RBI in a tight spot to find out the right balance between growth and inflation," says Milan Bavishi-Head Research-Inventure Growth & Securities.

Consensus is emerging that the RBI should react to slowing growth rather than to inflation dynamics by reducing policy interest rates on June 18. But RBI cannot ignore the effect of rate cuts on inflation, experts say.

"However, an independent central bank should not signal policy easing immediately as: (1) risks to inflation are strong, (2) core inflation is unlikely to come off significantly in the near-term and (3) slower growth is essential to keep a lid on inflationary expectations in the economy given the loose fiscal stance," says Indranil Pan.

Even as the RBI recently indicated that it now has the 'elbow room' to cut repo rates due to lower global commodity prices, it also pointed out to the balancing factors, especially the sticky fiscal problem. "It would be prudent for the RBI to sit on the sidelines at the moment and pass the ball into the Government's court to act on reviving investor demand and thus stabilising growth," says Indranil Pan.

The RBI policy meeting on June 18 would be important in deciding the future course of direction for the markets. Even the borrowers have their fingers crossed as they are anticipating at least 0.25% cut in repo rates so that their loan burden gets lowered.

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