RBI needs to hike rates by at least another 2%: Lloyds TSB

Trevor Williams, Economist, Lloyds TSB Corporate Markets feels the Reserve Bank of India or the RBI needs to raise rates at least another 2% points more. He believes that the Indian real interest rates are negative - they are - 1.75% and that is a problem.

"If you take account of nominal interest rates and match it to nominal inflation, you have negative real interest rates, which would generally add to further inflation pressure."

According to Williams, the interest rates must become positive in real terms, which implies in increase of at least 75-bps and it requires more than that to be down on inflation. "So I am afraid, you are looking at an increase of between 1-3 percentage points at least in Indian interest rates in the coming months or so."

Excerpts from CNBC-TV18's exclusive interview with Trevor Williams:

Q: The Indian inflation picture is getting worse. Week after week percentage rise is between 0.3% and 0.4% and at the moment it looks very clear that the inflation perceivable peak at this point in time clearly looks like 13%. Would you say that you would expect very strong action from the central bank?

A: First of all, they have already taken some action of increase in reserve requirements. They have raised nominal interest rates but perhaps one could argue that they should have acted a bit earlier and in a sense should have seen the rise in inflation come in simply because of these sharp increase that was taking place in global oil prices and in global food and other commodity prices.

Q: So, in your estimate, how much more do you expect the Indian central bank to go?

A: They need to raise rates at least two percentage points more. The problem is this - Indian real interest rates are negative - they are -1.75%. If you take account of nominal interest rates and match it to nominal inflation, you have negative real interest rates, which would generally add to further inflation pressure. So interest rates must become positive in real terms, which implies in increase of at least 75-bps and it requires more than that to be down on inflation. So I am afraid, you are looking at an increase of between 1-3 percentage points at least in Indian interest rates in the coming months or so.

Q: In terms of your growth estimates for India, what is it that you are penciling in right now because the market is talking about a growth slowdown from 7.5% to 7% - is there something that you are working with as well for India?

A: We are working with very similar figures which is a bit worrying if we are all agreeing on what the number is likely to be. Typically, when we disagree, we are all wrong. But we are looking for something like an average of 6.8% next year. For this year that we would probably think that India should see growths of about 7.9%.

Q: How do you see the global inflation picture panning out? We are seeing a one-way street as far as crude is concerned. Are you seeing any demand destruction and pressure coming in at any point in time in 2008 itself and more importantly for the other commodities, metals in particular, how is the price trajectory panning out and any signs of demand destruction?

A: I have to say, demand isn’t really slowing much and it is obviously a good thing, isn’t it? It is a function of the fact that the dynamics of growth in emerging markets is so strong that the industrialization process - building bridges, roads, factories, sewage plants, building infrastructure to take it from home to plants and so forth, means that one requires a lot of metal in the process. In a sense, it is good news that there is this strong demand for these metals, which drive infrastructure and industrialization, but it is also important that, that inflation in these areas don’t speed through to other parts of the economy. I don’t think as yet we have seen much reduction in demand for these products as a result of higher prices because the profitability of the industrialization that’s going on is still positive enough to mean that users of these can bear the price rises.

Moreover in 2009, given that interest rates have been raised that we will begin to see some reduction. We have seen most of the increase as well. Some metal prices have fallen and some have gone up. It is a pretty balanced picture here and we need to take into account that what we are seeing is a shift in relative prices.

Q: What would you pencil in byway of the Fed action for the next 12-months and what will pencil in byway of a rate action from the Chinese central bank in the next 12-months?

A: The Chinese central bank would raise interest rates more and they will revalue their currency as well to bear down on domestic inflation. The Fed will move interest rates into 2009 once it is clear that their economy is recovering. It is far to soon for the Fed to be raising interest rates but in 2009, US interest rates would move from 2% to 4% by the end of the year.