The Reserve Bank of India “has finally upped its game”, says Capital Economics. Late last week it surprised the markets with a 0.25% hike in interest rates. That was the first increase in two years. And it’s high time too, as inflation is becoming a “big problem”.
The benchmark wholesale rate has reached a 16-month high of just under 10% in February. That’s a far cry from the central bank’s ‘comfort level’ of 5%. Surging food prices have led the increase so far. But higher fuel prices and the overall growth rebound (which, according to Morgan Stanley, has lifted capacity utilisation rates “close to full”) mean inflation is set to go higher and won’t fall back rapidly.
Growth is expected to hit 8.2% in the year to March 2011. It is being buoyed by firm consumption (one estimate says Indian wages are set to jump by 10.6% this year, up from 6.6% last year) and the biggest jump in industrial production since 1994. So, dearer money is unlikely to derail the economy – unless the central bank lets inflation get out of control.A sharp tightening could cause a “hard landing”, warned Reserve Bank Governor Duvvuri Subbarao this week. Goldman Sachs reckons India is “complacent” about the risk.
“Inflation may be a bigger worry than anticipated,” says Prasun Gajri of HDFC Life Insurance. Uncertainty over the pace and extent of rate hikes may hamper a stockmarket that’s more than doubled in a year.
Another worry is the global picture. Exports comprise just 15% of GDP, so India’s economy is well insulated from a renewed slide in growth or another financial crisis. But its stockmarket isn’t. Indian equities are “highly correlated with the rest of the world”, says Morgan Stanley. Meanwhile, India’s Sensex index is “fully valued”, says Sanjeev Prasad of Kodak Securities. It’s Asia’s most expensive market on 21 times estimated earnings. So although a poll of Reuters analysts sees scope for the index to rise another 10% or so this year, this doesn’t seem the most compelling entry point.