 "Taimur Baig")
In our view, RBI's decision to take a pause in the last policy meeting of 2013 is inconsistent with its recent guidance. Despite the sharp upside surprise in November's CPI- and WPI-based inflation data, and the fact that surveys show inflation expectations have risen sharply, RBI chose to wait and see for further evidence of inflation.
Does RBI's reasoning stand up to scrutiny? The policy statement cites three arguments for the pause:
i) Vegetable prices, the key driver of inflation in recent months, have started falling in the past couple of weeks (in the first fortnight of December, daily prices of 10 food items tracked by us are down, by an average seven per cent on a month-on-month basis)
ii) A stable exchange rate will likely have a disinflationary effect
iii) Negative output gap and lagged impact of monetary tightening will limit further inflation.
Given that the data out-turn of the past couple of months have challenged the central bank's latest forecasts, and the conditions set in the latest statement for further action have already been met in the November inflation data and price expectation survey, we don't think the wait-and-see approach is in line with previous guidance. We do, however, appreciate the argument that some policy stability is needed for the economy and markets to consolidate. This is why we think the central bank will go on a prolonged pause after a rate hike in January.
Our forecast shows the WPI-based inflation rate in December to be at 7.5 per cent, but the CPI-based inflation rate may rise to 11.6 per cent from 11.2 per cent the previous month. Since the guidance about requiring a substantial easing of headline and core inflation would not be satisfied by this out-turn, we expect a 25-basis-point rate hike next month.
Beyond this, if wholesale inflation eases to 6.5-7.0 per cent by mid-June, RBI would not need to raise the policy rate further.
Taimur Baig
Chief economist (Asia), Deutsche Bank AG
Chief economist (Asia), Deutsche Bank AG
