RBI policy review: After repo rate hike, Raghuram Rajan says prefers to fight price rise

Written by Agencies | New Delhi | Updated: Jan 29 2014, 02:39am hrs
Raghuram RajanRBI policy review leads to 25 bps repo rate hike, Raghuram Rajan says inflation has to be brought down to sustain economic growth in medium term. (AP)
Reserve Bank of India (RBI) Governor Raghuram Rajan today said the 25 bps repo rate hike will help rein in consumer price rise at under 8 per cent by next January and denied speculation that the goalposts have been shifted to retail inflation and inflation targeting has been adopted.

"We should be able to reach the 8 per cent objective (on consumer price inflation) by the end of the year with this rate hike, which in turn will aid sustainable growth in the long term," Rajan told reporters at the customary post-policy interaction.

The Urjit Patel Committee on monetary policy framework 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. He added that CPI inflation at 8 per cent is a very "reasonable" target.

"It is premature to say that we are moving towards inflation targeting," he said, adding the committee's recommendations are being studied.

He said the RBI had been focusing on both the consumer price index (CPI) and wholesale price index (WPI) inflation numbers for some time now and feels the CPI component is important because of its direct correlation with the consumer, who is getting affected the most and needs to be protected.

Rajan said the RBI has to focus on disinflationary pressures in a weak economy.

"The 25 bps increase in the repo is needed to set the economy securely on the recommended disinflationary path," Rajan said.

On the potential impact of the rate hike on growth, Rajan said the RBI is cognizant of the weak state of the economy and added that the rate hike would not result in a spike in lending rates by banks.

"We need to create an environment for the recovery to be strong, inflation is a part of that. I'm not in any way giving up on growth in coming months or quarters and that RBI is cognisant of the weak state of economy.

"So, the best way to sustain growth over medium-term is to bring down inflation to a tolerable level during the course of the year which will give us more room to take policy action later on that will help growth," Rajan said.

The RBI's baseline projections for retail inflation indicate that over the ensuing 12-month horizon, and with the current policy stance, there are upside risks to the central forecast of 8 per cent.

Asked about the previous policy's guidance of a rate hike only if data showed any signs of worsening on the price front, Rajan said he has not veered off the guidance.

"The decision was close. Last time (on December 18) it was close and we chose to wait. This time, we chose to act.

"This time, some of the noise created by vegetable prices was taken off. Still some aspects of inflation are sticky and not moving down. That is suggesting that we probably need a little more medicine," he said.

"The extent and direction of further policy steps will be data dependent, though if the disinflationary process evolves according to this baseline projection, further policy tightening in the near term is not anticipated at this juncture," the RBI governor said.

On clubbing the quarterly review of monetary policy and the macroeconomic & monetary developments report, generally released on the eve of the policy, Rajan said it was done to avoid any instance of second guessing.

When asked if he expects the rate hikes to be transmitted by banks, Rajan replied in the negative saying this will not have any direct impact on cost of funds for banks nor in the cost of borrowing for consumers.

The RBI Governor said one of the key reasons for the deposit rates being high is inflation, as cost of funds are linked to deposits rates, and therefore, as price rise eases, there will be faster transmission.

"If we cut policy rates, it won't have any impact on banks' cost of funds or lending rates for borrowers," Rajan stated.

RBI Deputy Governor Urijit Patel said generally it takes up to six months for monetary policy transmission.

On the recent depreciation in currency, Rajan said this is because of the exit of short term funds from the debt market.

He, however, said that long-term funds continue to be invested. The economy is better prepared to face any external shocks now, he added.

HIGHLIGHTS

* CPI too high, we need to bring it down: Rajan

* Inflation has to be brought down to sustain growth in the medium term: Rajan.

* We need to create an environment for recovery to be strong, inflation is part of that environment: Rajan

* Premature to say RBI is moving towards inflation targetting: Rajan

* Pre-2005 currency note withdrawal not to get black money, or prevent tax evasion, but to reduce counterfeiting: Rajan

* We are aware of the weak state of economy; best way to sustain growth is to bring down inflation: Rajan

CRISIL: Repo rate at 8% to lower CPI inflation to 8%

In an unanticipated move, the Reserve Bank of India (RBI) in its third-quarter review of the monetary policy hiked the repo rate to 8.0%. The RBI indicated that the move was necessary to bring down CPI inflation to 8% by January 2015, as recommended recently by the Urjit Patel Committee. RBIs emphasis on bringing down CPI inflation further to 6% over the next 24 months, suggests limited downside to interest rates in the coming months.

With this policy, the RBI has clearly shifted its focus towards achieving a stated inflation goal over the next couple of years. The future course of monetary policy will now be determined by the forecasts of CPI inflation, the new nominal anchor. We expect CPI inflation to average 8.5% during 2014-15.