Hiking rates based on just CPI will worsen matters
With the consumer price index (CPI) rising by 11.24% in November versus 10.17% in October and 9.84% in September, the market seems reasonably certain a 25 bps repo rate hike will take place in Wednesday’s policy, and some analysts are also suggesting RBI Governor Raghuram Rajan needs to take the bull by the horns and go for a 50 bps hike to kill all residual inflationary expectations. That would be premature and unwise. For one, a little over 3.3 percentage points of the November CPI is solely driven by the 61% hike in vegetable prices. Core CPI, though elevated at 8.2%, remains unchanged since last month.
Even those who argue that it is critical to nip inflationary expectations in the bud will not disagree that there is some problem, in the data perhaps, as the other inflation index—the WPI—shows the impact of the dramatic deceleration in economic growth. It is true WPI has been rising the last few months, but that was most likely the impact of the rupee and food inflation, and the latest PMI data suggests when fresh data comes out Monday, it will show a further slowing – while the input price index has fallen from 64.5 in October to 58 in November, the output price index has fallen from 55.3 to 51.9; both rose between September and October. Hopefully when RBI’s report on the monetary framework comes out, it will explain why one price index is responding to economic impulses and the other not. Indeed, since RBI has put out its projected CPI inflation target of 9% for the year absent of policy interventions, what the market needs to know is what level of policy rates it was looking at as appropriate.
Perhaps why, while saying RBI does not plan to use any one data point, Rajan has said he will look at giving the ‘weak economy more time than one would normally allow for it to reach a comfortable level of inflation … The weak state of the economy, as well as the good Kharif and Rabi harvest, will generate disinflationary forces that will help, and we await data to see how these forces are playing out’. Nothing shows that weak state better than the latest IIP which contracted 1.8% in October—although this was exacerbated by an exceptionally strong October last year, IIP growth in April-October has been zero this year. PMI data suggests IIP will likely pick up for November, also aided by a weak November 2012, but the pick up will be modest. Given how services have been slowing for the past 10 quarters, it’s difficult to see just what is making the CPI remain so strong. RBI needs to take a longer view and hold on to rates on Wednesday.