India: RBI interest rates on hold in 2004

The Reserve Bank last week released an important, albeit theoretical, report entitled 'Report on Currency and Finance'. It sets out the key policy theme for 2004 - managing the external sector in an open economy. That is to say, the importance of influencing the currency, exports and import prices in order to ensure general economic stability.

The report also highlights that the central bank is clearly bullish about growth and is becoming more concerned about inflation. Although there was no direct statement indicating a change in policy and previous economic forecasts were reiterated, the central bank clearly indicated that the risks to their forecasts have now changed. This is particularly true on the inflation front as higher commodity prices, especially oil, and an accelerating global economic recovery impact.

The message is clear. In the backdrop of strengthening cyclical impulses, the central bank is clearly shifting focus to increased vigilance on inflation. That is in line with our view that further cuts in official rates are not likely.

However we do not believe that the RBI will tighten in 2004. We think that India is on the verge of a capex resurgence after a prolonged investment drought. Though signs of an incipient investment demand revival are evident from the capital goods production and import data, still no big projects are being announced. Corporates have implemented painful restructuring over the last few years and will be cautious in making new big-ticket capital commitment. In our view, that has the potential to delay the capex revival well into H2 2004.

Needless to say, the RBI is unlikely to jeopardise this much-awaited recovery by tightening pre-emptively.