Rajan prepares ground for rate hike on stubborn inflation

Central bank may opt for a cut in MSF rate as rupee stabilizes

Reserve Bank of India governor Raghuram Rajan has prepared the ground for increasing the repo rate– the second successive rate hike in two months – as inflation continues to remain above the central bank’s comfort level.  The central bank also sees modest improvement in growth in the second half of current financial year.

“Wholesale price index based inflation is ruling above the Reserve Bank’s comfort level and may remain range-bound around the current level during H2 of 2013-14. Moreover, the persistence of high CPI inflation remains a concern,” RBI said in its macroeconomic and monetary development report today.  

After declining to a 42 month low of 4.6 per cent in May 2013, headline inflation increased to 6.5 per cent (provisional) in September 2013 driven by a rebound in food and fuel prices.

The central bank has expressed concern on consumer price inflation CPI which continued to remain near double-digit levels driven by high food inflation. 

“Risks to inflation ahead are largely in balance from here on, though second-round effects from already high food and fuel inflation in CPI inflation could continue,” RBI said. 

The report said while a good kharif crop could partly mitigate the pressure on food prices, both at the wholesale and retail levels but upside risks remain which emanates from short-term domestic supply-side disturbances, the possibility of unforeseen global oil price spikes and possible adverse currency movements.

The central bank will announce its second quarter review of monetary policy tomorrow in which it is widely expected to hike the repo rate by 25 bps to 8 per cent. RBI is also expected to reduce the marginal standing facility rate – which was hiked in mid July to make short term money dearer amid a weak rupee – as the currency has stabilised.

Rajan, who took charge in the first week of September, had made it clear in his first policy review that fighting inflation will be his priority.

Economic growth – which fell to 17 quarter low in the first quarter is expected to rebound in the second half of the current financial year on the back of rebound in agriculture and an improvement in exports. 

“However, a fuller recovery is likely to start taking shape towards the end of the fiscal year on the back of current steps to clear impediments that were stalling projects,” RBI said.

While the central bank has noted that macroeconomic risks diminished in the recent months but risks still exist with some upward pressure on inflation and the possibility of fiscal slippage. Rajan also reminded that despite the recent exchange stability, he will continue to keep a vigil on the currency market.

“There is little scope for complacency at this stage, even though the rupee has gained strength,” the RBI report said.

Commenting that monetary policy faces an unenviable task of anchoring inflation expectations, even while growth remains tepid, the central bank highlighted the need for complementary action for supporting growth by productivity-enhancing structural reforms, addressing supply constraints and ensuring quick project implementation.