RBI tells street to look through transient effects, including base effect

With Raghuram Rajan taking over as governor of central bank last year, focus of monetary policy shifted more towards CPI inflation

Along with moving to Consumer Price Index (CPI)-inflation as anchor, the Reserve Bank of India (RBI) on Tuesday communicated the street to look through transient effects, including base effect, and not just the monthly CPI prints.

This is because a certain section of the market starts drawing conclusions about RBI's policy decisions when such monthly prints are released every month.

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

Under the reign of Raghuram Rajan as the governor of the central bank last year, the focus of monetary policy shifted more towards CPI inflation. Today key policy rates were kept unchanged by RBI.

RBI hiked the repo rate by a quarter percentage point to 8% in January. In the same month the Urjit Patel committee recommended that in the view of the elevated level of current CPI inflation and hardened inflation expectations, supply constraints and weak output performance, the transition path to the target zone should be graduated to bringing down inflation to 8% over a period not exceeding the next 12 months and 6% over a period not exceeding the next 24 month period before formally adopting the recommended target of 4% inflation with a band of +/- 2%.

"Just the headline inflation numbers will not drive policy decisions that is what they wanted to communicate. They just wanted to caution the market not to run with the headline number alone. RBI will look at all aspects of CPI inflation and not just the year-on-year print of CPI inflation," said A Prasanna, chief economist, ICICI Securities Primary Dealership.

Though Rajan said in the recent past that RBI has not moved into inflation targeting as yet, economists believe to look through transient effects, including base effect makes perfect sense economically.

"Every time we look at softening of inflation one of the things that always comes up is the base effect. The base effect is a distortion. It is a distortion because inflation is being calculated with a base effect which was last year. What RBI is saying is that eliminate this distortion and look at it in a way objectively is inflation high or low given the current situations of the pricing situations we are in. Economically this makes perfect sense," said Anis Chakravarty, senior director, Deloitte India.