The Raghuram Rajan effect: Stocks rally, bond yields crash

Press Trust of India Posted online: Wednesday, Dec 18, 2013 at 0000 hrs
Mumbai : Three months into his new job, RBI Governor Raghuram Rajan today moved to shed his hawkish inflation stance and surprised the markets and analysts by unexpectedly holding key rates.

This comes barely a week after both retail and wholesale inflation continued to climb, leading to expectations of another rate hike.

The RBI decision boosted equities and sent bond yields crashing 13 basis points. The rupee gained intra-day but pared the gains ahead of the US Fed meeting outcome.

Raghuram Rajan was vocal about the impact of his decision when he refused to be identified in the league of either former US central bank chief and inflation hawk Paul Volcker or the more accommodative Janet Yellen, nominated to lead the Federal Reserve.

"Your Volcker, Yellen etc... how about a Raghuram Rajan (effect)?" RBI Guv quipped when asked which camp he belonged to after he shed his hawkish inflation stance.

In a surprising move, Raghuram Rajan left the repo, or short-term lending rate, and the cash reserve ratio unchanged at 7.75 per cent and 4 per cent, respectively.

"The high level of CPI inflation, excluding food and fuel, leave no room for complacency. There is, however, reason to wait before determining the course of monetary policy," Raghuram Rajan said in the Mid-Quarter Monetary Policy Review.

"I should end with a description of what we have been doing in the last few months. I think it is course of the elephant - we say what we will do, we do what we said," Raghuram Rajan later told analysts on a conference call.

The decision came even as wholesale price index-based inflation quickened to a 14-month high of 7.52 per cent in November, while consumer price index inflation accelerated to 11.24 per cent, strengthening the view of market participants of an at least 25 basis point (bps) rate hike.

"There are obvious risks to waiting for more data, including the possibility that tapering of quantitative easing by the US Fed may disrupt external markets and that the Reserve Bank may be perceived to be soft on inflation. The Reserve Bank will be vigilant," Rajan said.

Explaining the RBI's rationale for today's policy stance, the Governor said, "We are not soft on inflation. We are waiting for more data. As the data come in, we will react appropriately."

The apex bank's decision was a big relief to borrowers and the markets, with the Sensex gaining 248 points to end at 20,859.86. The 10-year government bond yield fell 13 basis points to end at 8.78 per cent as against 8.91 per cent during the opening trade.

Rajan said he expects stronger growth in the second half of this financial year, aided by higher expansion in agriculture, exports and a revival in stalled projects.

The Governor, who took charge in early September, said he would stick with the earlier 5 per cent growth projection for the full year, with minor fluctuations.

Raghuram Rajan exuded confidence in the government's ability to meet the fiscal deficit target of 4.8 per cent of GDP. A cut in government spending, increase in disinvestment and greater revenue from state-owned companies will help meet the target.

Expressing happiness over the way the rupee is faring, Rajan said, "We are happy with the reduction in volatility and that was our aim right through.

"We also wanted to reduce the unhinged expectations on the rupee. There was a point where analysts were competing with each other to see how weak they could proclaim the rupee to be at the end of the year... We hope that unhinging of expectations has come down."

Talking about the external environment, Raghuram Rajan said it is not something to be complacent about and the RBI is fully prepared to deal with any volatility that may come once the US Fed starts tapering its bond-buying programme.

"We are certainly focused on the external environment. We are better focused to withstand the volatility stemming from tapering," he said.

The Governor said he is comfortable with the prevailing level of the current account deficit (CAD), which narrowed to 1.7 per cent of GDP in the second quarter from 4.9 per cent in the first quarter.

The Governor, however, said, "I would be much happier if we had the kind of CAD we have without significant curbs on anything, including gold."

"We should aim to have a (lower) CAD without any distortions, that is what we will be working for," Raghuram Rajan said.

Later talking to analysts, the RBI chief, however, maintained time is not ripe to lift the existing curbs on gold imports. "At this point, it will be premature to withdraw these restrictions for a variety of reasons."

Rajan said the recent rise in India's forex reserves, which stood at around USD 295 billion as of December 6, is the result of two concessional swap windows the central bank had opened between September 4 and November 30.

RBI has no plans to buy dollars directly from the market, he said. "We are not targeting an exchange rate and, therefore, not going into the market and buying reserves at this point to increase the foreign exchange reserves."

State-run oil marketing companies have about USD 7 billion in pending settlements after they availed of the central bank's special swap window to meet their dollar needs.

OMC had swapped USD 12 billion from the separate oil window which was opened from August 28 to the first week of December.