Apex bank adopts retail inflation as anchor

Projects 8% consumer price index-based inflation by Jan 2015, 6% by Jan 2016

Along with moving to Consumer Price Index (CPI)-based inflation as anchor, as recommended by the Urjit Patel Committee, the Reserve Bank of India (RBI) on Tuesday communicated to the Street to look through transient effects, including the base effect, not only monthly CPI data. This is because a certain section of the market starts drawing conclusions on RBI's policy decisions when such monthly data are released every month.

Earlier, the central bank had appointed a panel headed by RBI Deputy Governor Urjit Patel to revise and strengthen the monetary policy framework.

"It is critical to look through any transient effects, including these base effects, which could temporarily soften headline inflation during 2014," Governor Raghuram Rajan said in his monetary policy statement.

In this first bi-monthly monetary policy review, a format suggested by the Urjit Patel committee, RBI on Tuesday implemented some of the recommendations of the panel. These included adopting CPI-based inflation as an anchor, explicitly recognising the glide path for disinflation and reducing banks' dependence on overnight funds through the liquidity adjustment facility window.

In line with the panel's report, the central bank has projected eight per cent CPI inflation by January 2015 and six per cent by January 2016, while growth in gross domestic product for 2014-15 is seen at five-six per cent.

In January, RBI had raised the repo rate by 25 basis points to eight per cent. In the same month, the Urjit Patel committee had recommended due to the high CPI inflation, hardened inflation expectations, supply constraints and weak output, inflation of eight per cent should be targeted in up to 12 months and six per cent in up to 24 months, before formally adopting the recommended target of four per cent (+/- two per cent).

"The headline inflation numbers alone won't drive policy decisions; that is what they wanted to communicate to the market. RBI will look at all aspects of CPI inflation, not just the year-on-year print," said A Prasanna, chief economist, ICICI Securities Primary Dealership.

Though Rajan, in the recent past, has said RBI hasn't moved to inflation-targeting yet, economists believe to look through transient effects, including the base effect, makes sense economically. "Every time we look at softening of inflation, one of the things that comes up is base effect; the base effect is a distortion because inflation is being calculated with a base effect-last year. What RBI is saying is eliminate this distortion and look at it in an objective way-is inflation high or low given the current pricing situations? Economically, this makes perfect sense," said Anis Chakravarty, senior director, Deloitte India.