In policy debut, RBI chief Raghuram Rajan prescribes bitter pill

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Reserve Bank of India (RBI) Governor Raghuram Rajanis expected by many in the market to shift the RBI's main inflation gauge to consumer prices from wholesale prices. (Reuters) Reserve Bank of India (RBI) Governor Raghuram Rajanis expected by many in the market to shift the RBI's main inflation gauge to consumer prices from wholesale prices. (Reuters)
SummaryRBI governor may increase policy rates, risks prolonging lowest growth to suppress inflation.

Reserve Bank of India Governor Raghuram Rajan may raise policy rates again after shocking markets by increasing them in only his first meeting, signalling he is willing to risk prolonging what is already the lowest economic growth in years in order to quash persistent inflation.

Raising the repo rate by 25 basis points to 7.50 percent as India stumbles through its worst economic crisis since 1991 puts pressure on New Delhi to relieve supply-side bottlenecks in the economy, such as poor infrastructure, that keep inflation high even when demand is soft.

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That is a big ask for a weak coalition government, which also faces a general election by May.

Rajan is expected by many in the market to shift the RBI's main inflation gauge to consumer prices from wholesale prices, putting India in line with most big economies but pushing up near-term rate expectations. Consumer price inflation was 9.5 per cent for August, meaning the cost of living is rising faster than interest rates. The wholesale price index rose 6.1 per cent.

"If he goes ahead and hikes further, which I think he might, then it might affect growth. But ultimately, if you have to bring down inflation, there is no other option," said A. Prasanna, economist at ICICI Securities Primary Dealership Ltd in Mumbai.

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A prominent former IMF chief economist who famously predicted the global financial crisis, Rajan took office earlier this month amid much media fanfare and high expectations that he could engineer a turnaround for the sluggish economy and rescue a currency that had fallen as much as 20 percent this year.

A flurry of measures by Rajan's predecessor and fresh moves on his first day in office have helped lift the rupee off its record low.

Rajan rolled back part of the sharp increase in the marginal standing facility (MSF), an overnight rate, reassuring some in financial markets that the rupee measures are temporary. But in raising the repo rate, traditionally the policy interest rate, Rajan showed the central bank's priority had shifted from defending the rupee to fighting inflation.

"It should bring down inflation expectations and help correct India's macroeconomic imbalances. However, this means severe growth pain in the coming year," Nomura analysts wrote.

Nomura now expects the RBI to raise the repo rate by another 50 bps in

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