Rajan surprises markets with status quo on rates

Written by fe Bureau | Mumbai | Updated: Dec 19 2013, 09:57am hrs
THE Reserve Bank of India (RBI) may have sprung a pleasant surprise on the markets on Wednesday by choosing not to raise policy rates at a time of raging consumer and wholesale inflation 11.24% and 7.52% respectively in November but as governor Raghuram Rajan said, the decision was a close one. While the central bank believes inflation is very high, it didnt want to be overly reactive choosing instead to wait it out for the next set of readings.

Our sense is the recent numbers add a lot of noise and another month wont put us behind the ball, Rajan observed at a press conference after the monetary policy announcement. The governor, however, made it clear the central bank wasnt about to postpone a decision forever and that there was no room for ambiguity.

If the expected softening of food inflation does not materialise and translate into a significant reduction in headline inflation in the next round of data releases, or if inflation, excluding food and fuel does not fall, the Reserve Bank will act, including on off-policy dates if warranted, Rajan said.

Since economists believe that inflation could remain sticky and therefore monetary tightening would be necessary, it's possible that policy rates could be hiked sooner rather than later. Leif Eskesen, chief economist for India and ASEAN, HSBC wrote: We would argue that inflation risks remain tilted to the upside and that further monetary tightening is needed to manage these risks.

Being potentially perceived as too soft on inflation could also pose risks to inflation expectations and the exchange rate, the latter especially in a Fed post-tapering world. Encouragingly, the RBI signalled that it would stand ready to tighten if headline inflation does not ease significantly on the back of lower food inflation or core inflation does not fall. As it turns out, it may well have to deliver on those promises soon, Eskesen wrote.

While the industry might breathe easy for the moment, corporate India will be dismayed at the single-minded focus of the central bank on inflation. The governor briefly highlighted the persisting weakness in industry in Q3FY14 and noted that cuts in government expenditure in Q4FY14 would add to the headwinds of muted consumption demand. Rajan said he would stay with the growth forecast for H2FY14, adding that he expected growth to be better than in the first half. However, there was nothing that suggested that continuing weak growth might persuade the RBI to change its stance.

Bankers, for their part, were relieved there had been no increase in rates; even if the policy rate had been upped, banks might have not followed it up with a hike in loan rate, given loan growth has been subdued. The majority of banks did not raise lending rates when the central upped the repo rate by 25 bps on October 29 although State Bank of India (SBI) did tweak its base by 20 bps.

The governor acknowledged there were risks to waiting for data, including the possibility the taper of quantitative easing by the US Federal Reserve might disrupt the external market but asserted the RBI would remain watchful.

Economists believe that inflation could remain sticky and therefore monetary tightening would be necessary. Leif Eskesen, chief economist for India and ASEAN, HSBC wrote: We would argue that inflation risks remain tilted to the upside and that further monetary tightening is needed to manage these risks. Being potentially perceived as too soft on inflation could also pose risks to inflation expectations and the exchange rate, the latter especially in a Fed post-tapering world. Encouragingly, the RBI signalled that it would stand ready to tighten if headline inflation does not ease significantly on the back of lower food inflation or core inflation does not fall. As it turns out, it may well have to deliver on those promises soon.

The central bank is expecting prices of vegetables to subside although it is anxious trading mark-ups may not allow a complete pass-through into retail inflation. Soaring vegetable prices have been a big reason for the jump in both the WPI and CPIMoreover, a more stable rupee at levels of 61-62 to the dollar, would also result in some degree of disinflation.

With no changes to policy rates, the repo rate under the Liquidity Adjustment Facility(LAF) remains at 7.75% , the Marginal Standing Facility rate and the reverse repo at 6. 75%. The cash reserve ratio (CRR) stays at 4% of net demand and time liabilities.