Inflation is RBI priority again

Mumbai :  Reserve Bank Governor Raghuram Rajan is full of surprises: On Tuesday, he unexpectedly raised a key policy rate by 0.25 per cent to set the economy securely on the recommended disinflationary path.

Better capitalised banks can borrow at lower cost to lend more, says Rajan.
Better capitalised banks can borrow at lower cost to lend more, says Rajan.

It was widely expected that Rajan would maintain the status quo on rates to support growth. But the third quarter review of monetary policy by the Reserve Bank of India has revisited the growth-inflation trade-off, calling it a ‘false trade-off’ and giving priority to inflation.

The RBI Governor explained that the decision to hike interest rates was a close one. Consumer price inflation had eased to a three-month low of 9.87 per cent in December but it still remains well above the central bank’s comfort levels. Stating that the RBI will continue to target inflation, Rajan said, “Let’s fight the fight that needs to be fought.” Ahead of the quarterly review, Rajan had termed inflation a “destructive disease.”

But the RBI boss denied speculation that the goalposts have been shifted to retail inflation and inflation targeting has been adopted. The Urjit Patel Committee on monetary policy framework had set a retail inflation target of 8 per cent by January 2015. The panel’s recommendations include shifting the goalposts to consumer price inflation and inflation targeting.

Rajan, however, denied that the RBI has adopted any of the suggestions formally and said it will have to be done in consultation with the government.

Rajan also said that he was not giving up on growth for the next few quarters. “I am confident that inflation will be brought within tolerable limits, which will give room on the monetary front,” he said.

He hopes to bring consumer price inflation down to the 8 per cent objective by end of the year with this rate hike. If retail inflation eases as projected, Rajan does not foresee further near-term monetary policy tightening. In fact, he indicated a pause in terms of further rate hikes.

But analysts do not agree. HSBC economist Leif Eskesen expects more rate increases from the RBI. “This was the right decision, but it does not constitute the end to the tightening cycle, in our view. If RBI wants to knock out core inflation, the policy rate will likely have to be hiked further,” he told wire agency Reuters.

However, the RBI kept the cash reserve ratio unchanged at 4 per cent, as liquidity seems to be comfortable.

While industry expressed its “disappointment,” bankers said they would take a view on raising interest rates, depending on demand for credit and other factors.   The asset liability committee of the country’s largest lender, the State Bank of India, will review interest rates shortly. The EMIs for home and auto loans are expected to increase.

The policy rate has been increased thrice — 0.25 per cent each time — since Rajan took over as Governor in September.

Defending the policy stance, Rajan said a rate cut would not have affected banks or borrowers and that bringing down retail prices is the key to sustainable growth. “If we cut policy rates, it won’t have any impact on banks’ cost of funds or lending rates for borrowers,” Rajan told reporters at the customary post-policy press conference.

The Governor said economic growth would be below 5 per cent in the current financial year and could accelerate in 2014-15 to a mean projection of 5.5 per cent. He added that growth is likely to lose momentum in the third quarter of 2013-14. Economic expansion in the first half of 2013-14 was 4.6 per cent. In order to record a 5 per cent in the full year, second-half growth should be 5.4 per cent.

On the external sector, Rajan said a silver lining is the significant narrowing of the trade deficit on the back of resilient export growth. “The current account deficit for 2013-14 is expected to be below 2.5 per cent of GDP compared with 4.8 per cent in 2012-13,” he said.

Stocks fell sharply after the policy announcement and remained volatile through the day. The benchmark Sensex closed at 20,683.51, down 0.12 per cent.

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