It was stronger than expected and showed that the government and the Reserve Bank of India (RBI) seemed to agree that the war on inflation needed a decisive blow through a squeeze on money supply – even at the cost of foregoing some economic growth.
RBI governor Duvvuri Subbarao on Tuesday gave a decisive, hawkish push-up to interest rates with a 50 basis-point (0.5 percentage point) increase in the repo rate — at which commercial banks borrow from the RBI — taking it to 8%.
That was the eleventh jack-up in policy rates in 16 months since India started a battle against double-digit inflation fanned by domestic demand and a global rise in commodity prices.
Jittery stocks plunged. The benchmark Sensex of the Bombay Stock Exchange fell 353 points or 1.9% as investors and traders worried about that costlier money would do to corporate earnings. Both funding of industrial expansion and consumer loans for products such as cars depend on interest rates.
Market traders were looking for a calibrated 25 basis point hike, and their immediate reaction was that the stronger dose would choke growth.
However, RBI maintained its projected real GDP growth rate for 2011-12 at 8% while acknowledging that there were signs of moderation in interest rate-sensitive sectors. The focus, nevertheless, was on curbing demand by squeezing money.
RBI revised its baseline projection for inflation for March 2012 from 6% earlier to 7%. It is currently at 9.44%.
“The recent increase in domestic administered fuel prices and the minimum support price for certain food items will keep inflation under pressure,” said Subbarao. “Considering the overall growth and inflation scenario, there is a need to persevere with the anti-inflationary stance.”
“Growth will get sacrificed for the future as capital formation in the economy is the biggest concern now, bigger than inflation, and these steps will derail it further,” said Aseem Dhru, CEO, HDFC Securities. “If this continues we may end up with high interest rate, high inflation and low growth.”
Rate sensitive stocks plunged. The realty index was down 3.55% followed by the capital goods index (3.5%), banking index (2.46%) and automobile index (2.1%) .
Market experts say companies are already putting off capital expansion plans."The resultant moderation (from the rate hike) in the domestic economic growth rate may be more than expected, and the deceleration in the credit growth may help augment the gilt (government securities) appetite of the PSU banks," said Sandesh Kirkire, CEO, Kotak Mahindra Asset Management.