Archive for July 29th, 2008

RBI tightens rates at Q1 2008-09 review of Monetary Policy

July 29, 2008

RBI in its first quarter review of monetary policy tightened interest rates. One can also see the press release for a quick preview. 

The policy actions are:

  • Repo rate increased by 50 bps to 9%.
  • Cash reserve ratio increased by 25 bps to 9.0% with effect from the fortnight beginning August 30, 2008
  • Reverse repo rate unchanged

The monetary  policy stance is pretty stern on inflation (hawkish in monetary policy lingo) and says:

The overall stance of monetary policy in 2008-09 will broadly continue to be:

  • To ensure a monetary and interest rate environment that accords high priority to price stability, well-anchored inflation expectations and orderly conditions in financial markets while being conducive to continuation of the growth momentum.
  • To respond swiftly on a continuing basis to the evolving constellation of adverse international developments and to the domestic situation impinging on inflation expectations, financial stability and growth momentum, with both conventional and unconventional measures, as appropriate.
  • To emphasise credit quality as well as credit delivery, in particular, for employment-intensive sectors, while pursuing financial inclusion.

Notice the term inflationary expectations being repeated. It has been mentioned 18 times in the report! Inflation expectations are extremely important (my report explains the importance of managing inflation expectations)

RBI has also revised its inflation forecasts for the year:

While the policy actions would aim to bring down the current intolerable level of inflation to a tolerable level of below 5.0 per cent as soon as possible and around 3.0 per cent over the medium-term, at this juncture a realistic policy endeavour would be to bring down inflation from the current level of about 11.0-12.0 per cent to a level close to 7.0 per cent by March 31, 2009.

This was important as inflation of 5% – 5.5% was simply not achievable. It is important to have flexibility in inflation targets. I have also noted that inflation targeting central banks though say these targets are flexible, have not revised their targets. End result, confusions.

RBI has also lowered its growth projections:

GDP growth projection for 2008-09 revised from the range of 8.0-8.5 per cent to around 8.0 per cent, barring domestic or external shocks.

I have been noticing numerous comments in media on their concern for falling growth.  True growth may have moderated/ may moderate but there is no choice between such high inflation and growth. Growth can still be brought on track, inflation if it goes out of hand can be really nasty. People interested in understanding issues with inflation may go through this St Louis Fed publication on inflation mess in 1970s.

Interestingly, given inflationary concerns markets were divided over rate hikes prior to policy. This article from Tamal Bandyopadhyay prior to mon policy was really amusing:

The market is divided on the stance of the July review, the last in the Reddy regime. Those bankers and bond dealers who strongly feel that the time is ripe to rein in Reddy’s aggression in raising rates, cite three developments to build their argument.
 
First, the drop in the wholesale price-based inflation from 11.91% to 11.89% for the week ended 12 July, the first such drop in two months.
 
Second, a decline in industrial production. The year-on-year growth rate in industrial production in May fell to 3.8%, its lowest in six years.
 
Finally, they point to a drop in crude oil prices.
 
I understand people have full right to make their own views but clearly something is wrong if people say RBI should not hike interest rates given the above three reasons. Inflation at 11.89% is anything but a decline (more on this here), IIP numbers need to be revised, and crude oil prices are extremely volatile and it is too early to say of the declining trend. For oil prices to decline, emerging markets need to slowdown quite a bit. Clearly, we can’t have both high growth and low inflation forever.
A central bank’s primary concern is inflation and it is nice to see RBI hiking rates more than market expectations. It has made its stance clear. It is serious about managing inflation.
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Central Bank of Chile…very impressive

July 29, 2008

I was just taking a look at the website of Chile’s Central Bank and was mighty impressed with the research potential. Their research work is high quality and needs to be read. One usually does not expect a small Latin American country to focus on research.

It has a good amount of research papers presented in its annual conferences, and one should also check out its series of books on central banking.

Good work!

Assorted Links

July 29, 2008

1. Krugman says house prices  are still high. He also points Fed Funds rate has fallen but mortgae rates continue to be high

2. WSJ Blog points to a paper showing limited migration in EU. It points Mishkin makes his last push for inflation targeting in US


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