Great move Dr. Rajan and is playing bogey your favorite game?

Another RBI monetary policy under Dr Rajan (third policy) and yet again he plays bogey with markets. When most expected a rate cut he hiked rates and now when most expect rate hike, he chooses to pause. Markets have obviously rejoiced.

This is a great policy by Dr Rajan. I mean CPI inflation has just touched its highest at 11.24% and WPI at 7.5% is highest in last 14 months. Core CPI has been around 8% and rose from sub-8% to above 8% in Nov-13. Only worry is core WPI which is so low at 3% as per Nov-13 reading. So what else can RBI do then rejoice and pause. I mean India is shining after all and it indicates in our record inflation levels. We have the highest inflation in G-20 countries which is a matter of pride. Infact it should have cut rates to boost the market sentiment further..

Jokes aside,  what is Dr Rajan thinking is anyone’s guess. It is just getting more and more confusing. On inflation, RBI says:

Retail inflation measured by the consumer price index (CPI) has risen unrelentingly through the year so far, pushed up by the unseasonal upturn in vegetable prices, double-digit housing inflation and elevated levels of inflation in the non-food and non-fuel categories.

While vegetable prices seem to be adjusting downwards sharply in certain areas, the feed-through to much-too-high headline CPI inflation remains to be seen. Wholesale inflation has also gone up sharply from Q2 onwards, with upside pressures evident across all constituent components.

High inflation at both wholesale and retail levels risks entrenching inflation expectations at unacceptably elevated levels, posing a threat to growth and financial stability. There are also signs of a resumption of high rural wage growth, suggesting second round effects that cannot be ignored. High and persistent inflation also increases the risks of exchange rate instability. 

Perhaps RBI should also publish a list of markets where prices are actually declining and sharply at that. We will be just happy with some decline…

I mean when the statement itself mentions more risks to inflation, why pause? Unless you telling me guys the prices are expected to come much lower, I can still understand. And it is not just food. Core CPI is up at 8% and has remained around these levels for a while.


Recent readings suggest that headline inflation, both retail and wholesale, have increased, mainly on account of food prices.  While CPI and wholesale price index (WPI) inflation excluding food and fuel have been stable, despite a steady and necessary increase in administered prices towards market levels, the high level of CPI inflation excluding food and fuel leaves no room for complacency. There is, however, reason to wait before determining the course of monetary policy. There are indications that vegetable prices may be turning down sharply, although trading mark-ups could impede the full pass-through into retail inflation. In addition, the disinflationary impact of recent exchange rate stability should play out into prices. Finally, the negative output gap, including the recent observed slowdown in services growth, as well as the lagged effects of effective monetary tightening since July, should help contain inflation.

The policy decision is a close one. 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.

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. Even though the Reserve Bank maintains status quo today, it can help guide market expectations through a clearer description of its policy reaction function: if the expected softening of food inflation does not materialise and translate into a significant reduction in headline inflation in the next round of data releases, or if inflation excluding food and fuel does not fall, the Reserve Bank will act, including on off-policy dates if warranted, so that inflation expectations stabilise and an environment conducive to sustainable growth takes hold. The Reserve Bank’s policy action on those dates will be appropriately calibrated.

Just mumbo-jumbo in the end-  policy reaction function etc etc..

Actually what is more bizzare than lack of reason for no action, is this random change in policy stance.

The above reasoning of output gap, food prices leading to high CPI were applicable in Sep-13 Mid Q Review and even in Oct-13 review as well. Perhaps more so. CPI was around 9%, WPI below 7% and so on.

How is it that RBI chose to increase rates then?  Obviously at that time the idea was to show the inflation credential of the new Governor. Though one may ask should rates be hiked just to please the Governor and increase his ratings? But we can ignore these questions for time being.

So fair enough. Rates were raised, but as no banks really raised the rates nothing much happened. So both things happened – the new Governor built his credibility (as a la Volcker) and did not even hit economy via high rates. But then other thing called inflation was not impressed and moved in the only direction it has been moving in last 4 years or so – upwards…

Just when people were warming up to high rates comes a pause at a really unexpected time.

  • Was inflation a much bigger risk then compared to today? I mean it is fine if you back it with data and guidance. But there is nothing really. How do just two rate hikes lead to low inflation and normalisation of policy rates?
  • If Fed tapering is a risk, you could choose to hold policy a day after. What is the big deal?
  • And why will RBI raise rates on a non-policy day when it does not raise them on the policy day? What will be the need to suddenly rush when the actual policy would be just 15 days away (assuming RBI decides to act after the next inflation reading on 14 Jan 2014, when the RBI Q3 review is on 28 Jan 2014). By reacting 15 days before will hardly change anything except again playing bogey with markets when no one is playing..

The thing is the RBI Governor is trying to do manage this holy trinity (not sure whether impossible) of keeping inflation low, keeping government happy (& quiet) and keeping markets happy. In reality, his objective should be to just look at the first. Others should just be discarded to the bin.

By just saying “Reserve Bank may be perceived to be soft on inflation” is not enough. The words should be matched by action.


One Response to “Great move Dr. Rajan and is playing bogey your favorite game?”

  1. Inflation in 2014 | Stephen Darori on 2014 Says:

    […] Great move Dr. Rajan and is playing bogey your favorite game? ( […]

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