RBI Governor does well to set the record straight
Given the tone of the last monetary policy statement on how RBI would act soon if it did not see an adequate movement in not just headline inflation but also the core numbers, many in the market interpreted this as another rate hike being just around the corner. While not ruling out a hike, RBI Governor Raghuram Rajan has done well to give a series of media interviews to set the record straight. He has broadly made a few points. For one, he has not put rate hikes on hold, he is merely waiting for more data points before he makes up his mind. Either way. Since much of the debate over whether rates should be raised centres around RBI’s inclination to, in line with global practice, use consumer price indices (CPI) instead of wholesale one, the clarifications given by the Governor are worth keeping in mind. While this paper has long maintained the new CPI is not robust enough to be trusted—though real economy variables are mostly trending down, CPI continues to be sticky—Governor Rajan has just said he doesn’t as yet fully understand the series, so it may be a good idea to wait a bit more and see how it behaves. One argument, for instance, is that the current spate of vegetable and fruits inflation—food inflation rose 14% between April and November this year as compared to 9.4% in the same period last year—is largely concentrated in the states that were affected by cyclone Phailin.
Rajan has also said it is important to keep in mind that, in a developing country like India, the lag effect of previous rate hikes, of falling government consumption and even the output gap could be longer than that in developed markets—in other words, patience is a virtue. In any case, he said, it is not as if RBI has been behind the curve—it has raised rates not once but twice—when it comes to fighting inflation. Rajan has also addressed the issue of inflationary expectations, the other argument used to ask for a rate hike—it is important, the traditional argument goes, to nip inflation in the bud since, if unchecked, inflationary expectations can get embedded. Given how inflationary expectations are more often than not influenced by current levels of inflation, Rajan has said there is also the issue of adaptive expectations that need to be considered. In other words, while not giving markets any sense of which way he will move, Rajan has made it clear he will not be railroaded into a rate hike. While inflation remains an RBI priority, he has said earlier, the economy is quite fragile and may not be able to take aggressive rate hikes. It is this newspaper’s view that, given the way WPI is falling, it may not even be necessary.