8 Oct 2009, ET Bureau
MUMBAI: Ever since Australia's central bank raised its cash rate on Tuesday markets have been on the lookout for the next candidate. In Asia, the central bank deemed most likely to tighten next is either the Bank of Korea or the Reserve Bank of India.
Korea's central bank is facing a property price bubble; India's is facing inflationary pressures. “Inflationary pressures in India are elevated because of drought conditions in key agricultural areas, exacerbated by the weakest monsoon season in decades. Inflation has also been stoked by government measures, such as "minimum support prices" to maintain agricultural prices and protect farmers. This is partly why food prices are soaring; vegetable prices are up 50% relative to a year ago,” Alistair Chan, economist at Moody’s Economy.com said.
Given these pressures, markets are betting that the RBI will withdraw monetary stimulus soon. Market expectations for higher interest rates have seen the rupee trade at its highest level against the dollar in over a year. In the past week the rupee has appreciated 3.5% against the dollar. A deputy governor of the RBI has stated that the RBI seeks low volatility, rather than a low value, of the rupee. This suggests that the bank will not intervene to prevent the rupee from strengthening further. Indeed, a stronger rupee would lower import prices, especially for fuel, a Moody’s Economy.com report added.
According to Chan, the RBI could begin raising its repo and reverse repo rates before the end of the year, although it is likely to wait until the start of 2010. It is also likely to take a gradual approach, which may involve increasing banks' cash reserve ratios first. The RBI will walk a fine line between dampening inflation while keeping growth robust, but to its credit it has successfully navigated similar situations before.
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