RBI refuses to react to 'noise', puts govt on notice

Don't treat this as a pause, Rajan says, as risks to core inflation remain in coming months if US tapering begins next year

 

RBI governor Raghuram Rajan's decision to hold interest rates is best not interpreted as a "pause". All that the governor has decided to do is put the inevitability of a rate hike on hold for now. The operating word is 'now.' Rajan has held on to rates this month because he has chosen not to react to the sharp spike in vegetable prices in November and the "noise" around it. But the fact remains that for the last four years, consumer prices have stayed near the double digits. 

 

For long, the market has sought a softening of stance as core inflation (manufactured products inflation) stood at 2.6 per cent in November, but given the risk to the currency from a possible tapering of US stimulus, even this cannot be taken for granted. Rajan reiterated this on Wednesday morning by saying that he is looking at the longer term trend rather than react to monthly or weekly data points. 

 

While the RBI may not be in a position to combat supply side issues with monetary policy levers, but surely the government can and by holding rates in December, the RBI has put the government on notice. If the headline inflation continues its upward trend, then a rate hike in January is inevitable. His justification for holding rates is this: "Recent readings suggest that headline inflation, both retail and wholesale, have increased, mainly on account of food prices.  While CPI and wholesale price index (WPI) inflation excluding food and fuel have been stable, despite a steady and necessary increase in administered prices towards market levels, the high level of CPI inflation excluding food and fuel leaves no room for complacency."

 

Over the last several weeks, Rajan has never once given the indication that his focus is shifting to growth. In a statement on 4 September, Rajan said: “The primary role of the central bank, as the RBI Act suggests, is monetary stability, that is, to sustain confidence in the value of the country’s money. Ultimately, this means low and stable expectations of inflation...” During the second quarter review of the monetary policy on 29 October, he again said: "It is important to break the spiral of rising price pressures in order to curb the erosion of financial saving and strengthen the foundations of growth."

 

So what's in store? Given the inflation trajectory in recent times, most economists are factoring in a rate hike, which is way overdue. Ritika Mankar Mukherjee of Ambit Capital says: "We reiterate our expectation of repo rate increases of 25-50 bps being administered over the rest of FY14."