inflation numbers will not justify any rate cut any time in the near future.
Interestingly, we also used a set of statistical tools to understand the impact of an interest rate increase on output growth. We estimated Impulse Response Functions (IRFs), which are simply a set of coefficients that summarise the propagation of shocks in any of the variables across all the others over a period of time. Looking at Graph 3, the IRFs show that the rate increase impacts the output over a sufficiently longer time horizon.
RBI has been steadfast in its approach of controlling inflation over the last 3 years. Interestingly, the latest round of diesel price increase will actually help inflation rates stabilise in the long term. This also borne out by the recent trends in inflation, which is on a downward trajectory. If we recall, diesel prices were increased by a sharp R5 in September, but the inflation rate based on the WPI has declined from 8.07% in September 2012 to 7.18% in December 2012. Clearly, a staggered increase in the price of diesel will free up productive resources for efficient allocation and this will neutralise the adverse impact in short-run. RBI can join the party on January 29 with a rate reduction to improve sentiments further.
This concludes the two-part series
The author is Director, Economics & Research, Ficci. Views are personal