Letter from Mumbai: Central bank’s cautious approach to policy rate

Published October 6, 2014
Reserve Bank of India Governor Raghuram Rajan gestures while 
addressing students at a college in Mumbai September 16. India’s 
economy is currently positioned to reach the bank’s 6pc inflation target 
by January 2016.—Reuters
Reserve Bank of India Governor Raghuram Rajan gestures while addressing students at a college in Mumbai September 16. India’s economy is currently positioned to reach the bank’s 6pc inflation target by January 2016.—Reuters

INDIA Inc, which has been clamouring for a policy rate cut, was once again disappointed last week when the Reserve Bank of India, the central bank, refused to reduce interest rates, citing risks from ‘food price shocks,’ and ‘from geo-political developments that could materialise rapidly.’

In his fourth bi-monthly monetary policy statement, Raghuram Rajan, the RBI’s cautious governor, kept the repo, a key policy rate, unchanged at 8pc. The repo is the rate at which the RBI lends overnight funds to banks on a daily basis.

The governor asserted that the central bank was committed to sustaining consumer price index (CPI), or retail, inflation at below 8pc by January 2015. It is also determined to achieve a target of 6pc CPI by January 2016.

“Achieving this stiff target will require RBI to remain vigilant on the interest rate front, in a scenario of GDP growth picking up,” said a spokesperson of Crisil Research, India’s largest independent and integrated research house. “Recent data suggests that growth is showing signs of recovery and inflation is stepping down. Nonetheless, the potential risks to inflation in the months ahead, once the base effect vanishes, remain high and thus, we stick to our call of a no change in the policy rate this fiscal.”

But business lobbies and industrialists were disappointed by Rajan’s refusal to cut rates, despite slackening inflationary pressures. “By all indications, the twin deficits — fiscal and current account — are well under control and core inflation has been trending downwards,” points out Chandrajit Banerjee, director-general, Confederation of Indian Industry. “On the other hand, industrial production has been muted. This could have been a good opportunity for RBI to reduce rates. The infusion of liquidity at this juncture, through a reduction in policy rates, would have provided an impetus to the feel-good factor brought on by the recent burst of policy announcements by the government.”

According to A. Didar Singh, secretary-general, Federation of Indian Chambers of Commerce and Industry, as projects come on stream and the industrial economy starts moving, there will be greater demand for credit. “While we fully appreciate the measures taken by RBI in maintaining adequate liquidity in the system, I would like to mention the viability of fresh investments is impacted by many factors, including the cost of credit,” he notes.

Rana Kapoor, president, Associated Chambers of Commerce and Industry, points out that there would have been no inflationary risks if the RBI had eased policy rates a bit. More so, with crude oil prices having come down significantly and showing further prospects of reduction, and commodity prices in the global market seeing a downward trend.

Of course, the RBI had the strong backing of the International Monetary Fund, which last month urged it to increase policy rates to bring down inflation on a sustained basis. “Sustainably lowering inflation will also require further increases in the policy rate and a simpler monetary framework with clear objectives and operational autonomy for the RBI,” the IMF said in a note released ahead of the G20 meeting of finance ministers and central bank governors in Australia.

The IMF also expressed concerns about the quality and durability of the fiscal consolidation that has been initiated by the new BJP government at the centre. “The government should articulate structural measures to underpin the consolidation path, including subsidy reform and progress on the goods and services tax,” said the IMF.


INFLATION has come down significantly in India over the past few months, thanks to a variety of factors. These include the continuing slide in the price of international crude oil — it has fallen from a high of $107 a barrel at the beginning of the year to around $95 now — decline in other global commodity prices and also a surge in foreign exchange inflows that has steadied the Indian rupee.

The wholesale price index (WPI) — or headline inflation — fell to an almost five-year low for the month of August, when it plunged to 3.74pc from 5.19pc in July. The WPI stood at 1.8pc in October 2009.

But CPI, or retail inflation, continues to remain high at 7.8pc (for August), slightly lower than 7.96pc in July. However, the RBI’s comfort zone for retail inflation is 6pc, to be achieved in the medium-term.

Analysts, including those from Crisil Research, believe that over the next four months, headline CPI inflation could ease further as a strong base effect from the last fiscal kicks-in, lower crude oil prices create downward pressure on transport and communication inflation and proactive measures taken by the government help check a spike in food prices.

“Beyond January however, once the favourable base effect wears off, there is a possibility of headline CPI inflation gliding towards 8pc by the end of the fiscal year (March 31),” says the research agency. “This means that there is no room for a rate cut in FY15.”

Food prices have moderated at the wholesale level — coming down to 5.15pc in August from 8.43pc in July — but CPI-based food inflation is still high at 9.5pc. Food-price inflation is a very sensitive issue in India, and no government would like it to remain high in the long run.

So despite pressures from business lobbies, the Indian government is unlikely to push the RBI for a cut in interest rates, as long as food inflation remains elevated.

The continuous fall in global crude oil prices has benefitted the state-owned refiners and petroleum product marketing companies significantly. In fact, public sector oil majors have for the first time in recent years started making profits on the sale of diesel. In January 2013, the then government decided to wipe out the under-recovery in the highly subsidised fuel by allowing the oil companies to raise the price of diesel by 40 to 50 paise a litre every month.

With oil prices tumbling, the companies have started earning a profit of Rs1.9 on sale of every litre of diesel.

Published in Dawn, Economic & Business, October 6th, 2014

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