Markets have mostly factored in a 50-basis point rise in the cash reserve ratio (CRR), the level of cash banks must keep with the central bank, on Jan. 29 but recent strong data has raised expectations that policy rates might also be raised.
The wholesale price index rose 7.3 percent in December from a year earlier, its highest since November 2008 and accelerating from a 4.8 percent gain in November, data showed on Thursday. The reading matched analysts’ forecast in a Reuters poll.
The rise was driven by near 20 percent jump in food prices, which rose on weak monsoon rains and flooding in parts of the country, but inflation in manufacturing products picked up to 5.2 percent from 4 percent in November, a sign that inflationary pressures were spreading to other sectors of the economy.
“With expectations of maybe high and rising inflation now entrenched, the RBI (Reserve Bank of India) would start to counter them with tighter monetary policy, starting with a CRR hike in January review and gradual rate hikes post that,” said Gaurav Kapur, senior economist at ABN AMRO Bank in Mumbai.
Some central banks in Asia have already started to drain liquidity from the market as the economic recovery gathers pace. China surprised markets on Tuesday by raising banks’ reserve requirement ratio by 0.5 percentage point. The measure will take effect on Jan. 18.
A Reuters poll of economists on Dec. 2 showed that only one-third of respondents expected a rate hike in India by the end of January although all expected an increase by April.
However since then market rates have been rising after a run of strong data as well as China’s move lifted expectations that policy rates could rise sooner than later.
The 10-year government bond yield has risen more than 40 basis points over that period.
Markets showed little reaction to Thursday’s data but the six-month rupee overnight indexed swaps has risen to 4.24 percent, up 9 basis points since Tuesday when the People’s Bank of China made the surprise announcement.
At home, data also showed on Tuesday industrial output grew at faster-than-expected 11.7 percent in November from a year earlier.
The purchasing managers’ index rose to its highest since May in December while car sales rose an annual 40.3 percent last month.
“It (the WPI) is on the higher side primarily because of higher food prices, but going forward the likely wage-price spiral may give rise to a generalised inflation,” said Rupa Rege Nitsure, chief economist at the Bank of Baroda in Mumbai.
“So I expect RBI to give a strong liquidity signal in the January monetary policy review, whereby it could take measures to mop-up surplus liquidity from the system.”
The government, which is pressing the RBI to hold rates to ensure the $1.2 trillion economy’s recovery, ordered this week the sale of stocked grain and extended duty-free sugar imports by another nine months, hoping to rein in high food inflation.