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India vs RI: Parallelism in inflation and interest rates
India: Two days ago, the Reserve Bank of India (RBI) increased its two key policy rates on the back of continued inflationary pressure
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ndia: Two days ago, the Reserve Bank of India (RBI) increased its two key policy rates on the back of continued inflationary pressure. High inflation has developed into a big political dilemma in India. In fact, the hike surprised the market as the government came up with a 50-basis point hike in the reverse repo rate to 4.5 percent, more than the 25-basis point hike expected by analysts. This is the fourth time this year that India has raised interest rates (exhibit 1). Meanwhile, the repo rate was lifted by 25 basis points to 5.75 percent with the RBI highlighting the increase in demand-side price pressures.
Indonesia: Bank Indonesia’s benchmark rate currently at 6.5 percent has remained unchanged since July 2009.
India: Another concern for the RBI is rapidly rising food prices, particularly given monsoon rains since early June have been below “normal” levels. While crop production remains ahead on a year-on-year basis, there is a high risk that increases in food prices will continue to accelerate faster than expected going forward.
Indonesia: We saw unexpected sharp acceleration in annual headline inflation in June to 5.1 percent (Exhibit 2), the highest in the past 13 months, mainly stemming from higher food costs. While we initially thought that this was probably a one-off, the central bank has signaled that high inflation is likely to continue into July. With the fasting month starting in August, we believe inflationary pressure will continue into September, leading up to Lebaran, Indonesia’s biggest Muslim festivity.
India: Expectations are for interest rates to move up by at least another 100 basis points in the next 12 months.
Indonesia: Continued strong economic growth in 2Q10, we suspect, will soon increase capacity utilization, raising demand-side inflationary pressures as well. We expect that the year-to-date inflation will accelerate to 5 percent in 3Q10, hitting 6 percent by end-2010 from 2.41 percent in June. We expect annual headline inflation will also accelerate and is poised to nudge the top of the 4-6 percent BI’s target range by the end of the year.
India: Given recent developments, India’s monetary policy reviews will now take place around every six weeks, compared to every quarter previously. The market is currently looking for the RBI to hike rates by 25 basis points at their next meeting in mid-September. With policy rates continuing to climb, the government’s long-term bond yields should fall.
Indonesia: We expect a first BI rate hike to be brought forward to early 4Q10, ssuming uncontained inflation, which would lead to the reference rate being at least 50 basis point (bps) higher to 7.00b percent by year end, before increasing by another 100 basis points in 2011. In the bond market, increased domestic and global investor risk aversion has helped to reduce government bond yields with the 10-year now at 8.2 percent, compared to 10 percent in the
beginning of the year. Going forward, the risk in the bond market, however, is that upside for bond prices could be limited given that BI rates are likely to rise, in tandem with higher inflation.
The writer is senior vice president and head of Indonesia research at Bahana Securities
