Column: Surprisingly, RBI stays on hold

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SummaryThe central bank may be on hold for now, but don’t rule out more aggressive action later

India’s central bank surprisingly stayed on hold indicating that the “policy decision was a close one” but arguing that the recent surge in inflation (CPI at 11.2% and WPI at 7.5%) was mainly on account of food prices, and there is evidence that vegetable prices had moderated sharply in December, and therefore it would like to see another round of data before making a decision on policy rates.

The policy statement admitted that inflation was unacceptably high but pointed to the prevailing uncertainty at the future path of inflation, noting, “Current inflation is too high. However, given the wide bands of uncertainty surrounding the short-term path of inflation from its high current levels, and given the weak state of the economy, the inadvisability of overly reactive policy action, as well as the long lags with which monetary policy works, there is merit in waiting for more data to reduce uncertainty.”

The decision came as a surprise to markets that were bracing for a hike. To be sure, it’s perfectly understandable—and desirable—from the central bank to see through temporary supply shocks. Vegetable prices have undoubtedly moderated sharply in the month of December and that is expected to pull down both headline CPI and WPI next month.

But our belief that RBI would raise rates at this review was based on several other factors: (a) that, despite the sharp expected moderation in vegetable prices in December (with December CPI expected to dip below 10%), CPI inflation remains on course, to stay well above the 9% levels till March that RBI had forecast at the last review; (b) that, even without vegetables, the quarterly, annualised momentum of headline WPI (quarterly, annualised) is running about 10%—so inflation pressures are more broad-based than vegetables, (c) that non-food inflation pressures remain elevated: core CPI inflation has remained close to or above 8% for the last five months, and the annualised quarterly momentum of WPI core inflation is above 6% for the last three months, (d) that not doing anything at this review ran the risk of causing already-elevated inflation expectations from getting further entrenched, and (d) that, with rural wages re-accelerating, input price pressures still strong, the persistence of food shocks runs the risk of getting more generalised.

All these factors were acknowledged in a hawkish policy statement by RBI. Specifically, the statement argued that “high inflation at both the wholesale and retail level risks entrenching expectations at

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