RBI governor Raghuram Rajan has refrained from making any change in policy rates because he wanted to wait for ‘more data’ and ‘see through the noise’ over the rise in both retail and wholesale inflation, mainly driven by food prices, even as so-called core inflation that excludes food and fuel remained stable despite an increase in administered fuel prices. Photo: Ramesh Pathania/Mint
RBI governor Raghuram Rajan has refrained from making any change in policy rates because he wanted to wait for ‘more data’ and ‘see through the noise’ over the rise in both retail and wholesale inflation, mainly driven by food prices, even as so-called core inflation that excludes food and fuel remained stable despite an increase in administered fuel prices. Photo: Ramesh Pathania/Mint

RBI likely to keep policy rates unchanged

Despite a likely fall in both retail and consumer inflation in the coming months, a rate cut is unlikely any time soon

Three out of five bond dealers I spoke to over the weekend on the likely outcome of the Reserve Bank of India’s (RBI) 28 January quarterly monetary policy review expect no change in policy rates. One stuck his neck out and said there could be a rate cut, and another forecast a rate increase. Each has his own logic.

In the last review of monetary policy on 18 December, RBI governor Raghuram Rajan chose to keep the key policy rates unchanged despite retail inflation accelerating to 11.24% in the previous month, the highest since the data series was introduced in January 2012, and wholesale inflation spiking to 7.52%, the highest in 14 months.

Rajan refrained from making any change in policy rates because he wanted to wait for “more data" and “see through the noise" over the rise in both retail and wholesale inflation, mainly driven by food prices, even as so-called core inflation that excludes food and fuel remained stable despite an increase in administered fuel prices. He expected food and vegetable prices to come down sharply in December and January, pushing down both retail and wholesale inflation.

Rajan took a calculated gamble and it has paid off.

The December retail inflation declined to 9.87%—much below Bloomberg’s consensus estimate—on account of a sharp fall in vegetable prices. Wholesale inflation fell equally sharply—from 7.52% to 6.16%, a five-month low and significantly below the consensus estimate of 7%.

Overall, food prices contributed 85% to the 1.36-percentage-point drop in wholesale inflation in December. Vegetable inflation cooled to 57.3% year-on-year from a record high of 95% in November. Between July and November, vegetable prices had spiked close to 80% year-on-year, the highest since 1998. The fall in vegetable prices in retail inflation has been 18.4% month-on-month; in case of wholesale inflation, the drop has been 30%.

Weaker-than-expected wholesale inflation and below-consensus retail inflation in December as well as a 2.1% contraction in industrial output in November, lower than what most analysts had expected, after a 1.8% contraction in the previous month, will definitely create a more comfortable platform for the RBI governor to announce the policy review than what we had seen in January. But can he afford to go for a rate cut? Highly unlikely.

Even though headline inflation dropped, core retail inflation rose marginally to 8.1% from 8% in November and core wholesale inflation rose from 2.63 to 2.75%. Besides, the October wholesale inflation has been revised upwards—from 7% to 7.24%—and it is fair to presume that both November and December inflation figures have upside risks. Indeed, wholesale and retail inflation peaked in November, and from now on they will come down as food prices—the major contributing factor—see a modest fall in winter, but the risk of food inflation spilling over to core inflation remains high.

The rise in core inflation, albeit marginally, has prompted a few to bet on a rate hike as the 18 December policy document said that “if inflation excluding food and fuel does not fall, the Reserve Bank will act".

The recommendations of the Urjit Patel panel on monetary policymaking have also given a handle to those who have been pushing for a rate increase. The Patel committee is in favour of the central bank targeting inflation with headline retail inflation as the nominal anchor. It has set the medium-term target at 4% with a 2% band and in the transition phase, it says, RBI should target retail inflation at 8% over next 12 months and 6% over next 24 months.

If RBI accepts the committee’s recommendations, its stance is bound to be hawkish as the current level of retail inflation at 9.87% is much higher than the target of 8% for the next 12 months. The Patel panel has also made it abundantly clear that RBI’s top priority should be fighting inflation, giving it precedence over boosting economic growth and ensuring financial stability.

However, it is too early to expect Rajan drafting the quarterly policy in tune with the Patel panel report, particularly when the government does not seem to be excited about it. Economic affairs secretary Arvind Mayaram last week said it was a bit premature for India to consider Consumer Price Index inflation as the nominal anchor for monetary policy. The retail inflation measure has a lot of imperfections and inflation targeting would be difficult in India, Mayaram said. Finance minister P. Chidambaram, too, expressed strong reservations about the report. According to him, the central bank must keep the objective of supporting growth and “inflation targeting is only one among the objectives".

Against this background, I would not expect Rajan to rush for a rate hike when he announces the quarterly policy. He will probably favour the status quo. At the same time, it’s also fairly certain that despite a likely fall in both retail and consumer inflation in the coming months, we will not see a rate cut in Asia’s third largest economy any time soon.

Since he took over as central bank governor in September, Rajan has hiked the repurchase rate, or the rate at which RBI lends to banks, by half a percentage point to 7.75% from 7.25% in two stages, by a quarter percentage point each time.

Tamal Bandyopadhyay keeps a close eye on everything banking from his perch as Mint’s deputy managing editor in Mumbai. He is also the author of A Bank for the Buck, a book on HDFC Bank. Email your comments to bankerstrust@livemint.com

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