RBI Governor following a correct approach, says Montek Singh Ahluwalia

Commenting on the Reserve Bank of India's (RBI) decision to raise its policy interest rate by 25 basis points to 8 percent, Deputy Chairman of the Planning Commission Montek Singh Ahluwalia on Tuesday said the RBI Governor Raghuram Rajan is following a correct approach and wants to send a signal that necessary steps are being taken to control inflation.

"He (Rajan) is right to give the signal that we are going to do whatever is necessary to control the inflation and that we are not loosening up, so you should not feel that policy is out of control. Broadly, it is a correct approach. I don't think it was much of a case of lowering anyway," Montek told media here today.

"The industry wants lower and real rates. There is no doubt that if you want to develop the country rapidly, we need lower interest rates on loan from the banks. So he is saying that lowering of rates would not have been appropriate," he added.

Montek said the Governor of the Reserve Bank has made it clear that this sort of a very short adjustment in the short term rate doesn't actually mean that it will necessarily lead to a negative effect on the long term rate.

"More importantly, those who feel that by lowering the short term rate, he could have given a boost. I don't think that this will give a boost, because he made it very plain that the banks will lower their interest rates, if the cost of their funds goes down. The cost of their funds only goes down, when deposit rates goes down. As long as the inflation rate is little on the high side, this is not going to happen," he said.

Earlier today, The RBI unexpectedly raised its policy interest rate by 25 basis points to 8 percent.

The policy decision was driven by an expectation that consumer price index (CPI) inflation will remain high, an indication that the RBI is looking to adopt a recent proposal to base its policy rate decisions on a CPI target.

"Today on the basis of an assessment of the current and evolving macro-economic situation, we have decided to increase the policy repo rate under the liquidity adjustment facility by 25 basis points to eight percent," RBI Governor Raghuram Rajan had said.

Indian bonds, stocks and the rupee fell after the rate hike but soon recovered most losses.

Rajan added that the current account deficit for 2013-14 is likely to be below 2.5 percent of GDP (Gross Domestic Product) as compared to the previous year.

"The current account deficit for 2013-14 is now expected to be below 2.5 percent of GDP (Gross Domestic Product) as compared with 4.8 percent in 2012-13. The recent resumption of capital inflows with some turbulence should help finance the current account deficit comfortably," added Rajan.

Rajan faces the daunting challenge of reviving an economy growing at a decade low of around 5 percent while battling persistently rising prices, much of which has been fuelled by supply-side shortages beyond the control of monetary policy.