 "Hawkish action, dovish guidance from RBI")
Raghuram Rajan is making springing surprises a habit. The Reserve Bank of India (RBI) governor delivered four of those in the third-quarter monetary policy, unveiled on Tuesday.
First, at a time almost everyone in the market was expecting the status quo on the interest rates, Rajan, to fight inflation, raised the repo rate 25 basis points to eight per cent — his third rate hike since taking charge in September. “An increase in the policy rate will set the economy securely on the recommended disinflationary path,” RBI said. The decision came five days after Finance Minister P Chidambaram offered a reminder that the central bank, too, had a duty to push growth.
Pointing out there was no trade-off between growth and inflation, Rajan said: “If we cut policy rates, do you think banks will also cut rates? A cut in the policy rate is not going to create immediate demand.”
The second surprise came in the form of RBI’s guidance. It said if retail inflation eased as projected, further near-term monetary tightening was not anticipated. The markets, which had fallen sharply after the repo-hike announcement, drew relief from the statement and recovered some of its loss. But the statement surprised economists and analysts, who expected more tightening on the horizon.
ALSO READ: Silver lining: CAD likely to be within RBI's comfort zone after 3 years
In his post-policy media briefing, even Rajan didn’t sound very convinced about an end to the monetary-tightening cycle. “We have injected some medicine, 75 bps in rate hikes since September, and we have to watch to see how that medicine works, along with, again, the weak state of the economy and the stabilisation of the rupee,” he said.
There was a third surprise, too. Despite the finance ministry’s reservations on some recommendations of the Urjit Patel panel’s report, which had suggested making the retail inflation figure the nominal anchor, the policy statement made references to the report. It pointed to the “glide path” for disinflation suggested by the panel, where the objective was to have eight per cent retail inflation by January 2015 and below six per cent by January 2016. The rate hike, RBI said, was driven by expectations of high but moderating retail inflation, an indication the central bank intended to adopt the panel’s proposal to base its rate decisions on a retail inflation target.
Rajan also adopted the panel’s suggestion to review monetary policy every two months. Earlier, it reviewed policy eight times a year.
And, fourth, both Rajan and Patel took to ornithology to change the idiom of RBI’s policy stance.
“We are neither hawks, nor doves. We are actually owls,” Rajan said, answering a question on the self-contradiction in the policy, which is hawkish in its stance but dovish in its guidance because of indications of a pause. “An owl is traditionally a symbol of wisdom. We are vigilant when others are resting,” Patel, the deputy governor in charge of monetary policy, added.
RBI justified its rate hike action on the ground that the retail inflation rate stayed in double digits and there was an uptick in non-food manufacturing inflation. In addition, wage pressures were also evident, as inflation with respect to services was high.
The silver lining, according to RBI, was the external sector. The current account deficit (CAD) is expected to fall and, for the first time in three years, could come close to the central bank’s comfort level of 2.5 per cent. RBI predicts the deficit to narrow to 2.5 per cent of gross domestic product in 2013-14, compared with a record high of 4.8 per cent the previous financial year.
ALSO READ: RBI sees 5-6% economic growth in 2014-15
RBI said economic growth was likely to fall short of its earlier projection of five per cent this financial year and improve to five-six per cent in the year starting April 2014. Retail inflation, which eased to a three-month low of 9.87 per cent in December, was well above the wholesale price index (WPI), RBI’s main price barometer for long, which fell to 6.16 per cent in the month.
The central bank said retail inflation was likely to stay above nine per cent during the last quarter of the current financial year and range between 7.5 per cent and 8.5 per cent for the quarter that ends in March 2015, “with the balance of risks tilted on the upside”.
While banks would be keen to pass on the rate hike by increasing lending rates, lack of credit demand might come in their way, said bankers, who seemed to maintain the status quo on rates for now. Bankers were, however, not sure about the guidance. “You can never directly link the lending rate to the repo rate. Lending rates are dependent on our cost of funds. The deposits rates have not changed for many quarters. The reason is that deposit rates are linked to the inflation rate; you should give positive returns to your depositors,” said ICICI Bank Managing Director & Chief Executive Officer Chanda Kochhar.
Industry was disappointed. The Confederation of Indian Industry (CII) said the central bank should now focus on boosting investments and growth rather than containing inflation. Assocham said: “We seem to have been caught in some kind of a vicious circle, which is taking a huge toll on growth.”
After the initial knee-jerk reaction, markets settled down following the central bank’s dovish guidance. Bond yields softened to close at 8.75 per cent, compared with the previous close of 8.77 per cent, while the BSE Sensex closed 0.12 per cent down.
First, at a time almost everyone in the market was expecting the status quo on the interest rates, Rajan, to fight inflation, raised the repo rate 25 basis points to eight per cent — his third rate hike since taking charge in September. “An increase in the policy rate will set the economy securely on the recommended disinflationary path,” RBI said. The decision came five days after Finance Minister P Chidambaram offered a reminder that the central bank, too, had a duty to push growth.
Pointing out there was no trade-off between growth and inflation, Rajan said: “If we cut policy rates, do you think banks will also cut rates? A cut in the policy rate is not going to create immediate demand.”
The second surprise came in the form of RBI’s guidance. It said if retail inflation eased as projected, further near-term monetary tightening was not anticipated. The markets, which had fallen sharply after the repo-hike announcement, drew relief from the statement and recovered some of its loss. But the statement surprised economists and analysts, who expected more tightening on the horizon.
ALSO READ: Silver lining: CAD likely to be within RBI's comfort zone after 3 years
In his post-policy media briefing, even Rajan didn’t sound very convinced about an end to the monetary-tightening cycle. “We have injected some medicine, 75 bps in rate hikes since September, and we have to watch to see how that medicine works, along with, again, the weak state of the economy and the stabilisation of the rupee,” he said.
There was a third surprise, too. Despite the finance ministry’s reservations on some recommendations of the Urjit Patel panel’s report, which had suggested making the retail inflation figure the nominal anchor, the policy statement made references to the report. It pointed to the “glide path” for disinflation suggested by the panel, where the objective was to have eight per cent retail inflation by January 2015 and below six per cent by January 2016. The rate hike, RBI said, was driven by expectations of high but moderating retail inflation, an indication the central bank intended to adopt the panel’s proposal to base its rate decisions on a retail inflation target.
Rajan also adopted the panel’s suggestion to review monetary policy every two months. Earlier, it reviewed policy eight times a year.
And, fourth, both Rajan and Patel took to ornithology to change the idiom of RBI’s policy stance.
“We are neither hawks, nor doves. We are actually owls,” Rajan said, answering a question on the self-contradiction in the policy, which is hawkish in its stance but dovish in its guidance because of indications of a pause. “An owl is traditionally a symbol of wisdom. We are vigilant when others are resting,” Patel, the deputy governor in charge of monetary policy, added.
RBI justified its rate hike action on the ground that the retail inflation rate stayed in double digits and there was an uptick in non-food manufacturing inflation. In addition, wage pressures were also evident, as inflation with respect to services was high.
The silver lining, according to RBI, was the external sector. The current account deficit (CAD) is expected to fall and, for the first time in three years, could come close to the central bank’s comfort level of 2.5 per cent. RBI predicts the deficit to narrow to 2.5 per cent of gross domestic product in 2013-14, compared with a record high of 4.8 per cent the previous financial year.
ALSO READ: RBI sees 5-6% economic growth in 2014-15
RBI said economic growth was likely to fall short of its earlier projection of five per cent this financial year and improve to five-six per cent in the year starting April 2014. Retail inflation, which eased to a three-month low of 9.87 per cent in December, was well above the wholesale price index (WPI), RBI’s main price barometer for long, which fell to 6.16 per cent in the month.
The central bank said retail inflation was likely to stay above nine per cent during the last quarter of the current financial year and range between 7.5 per cent and 8.5 per cent for the quarter that ends in March 2015, “with the balance of risks tilted on the upside”.
While banks would be keen to pass on the rate hike by increasing lending rates, lack of credit demand might come in their way, said bankers, who seemed to maintain the status quo on rates for now. Bankers were, however, not sure about the guidance. “You can never directly link the lending rate to the repo rate. Lending rates are dependent on our cost of funds. The deposits rates have not changed for many quarters. The reason is that deposit rates are linked to the inflation rate; you should give positive returns to your depositors,” said ICICI Bank Managing Director & Chief Executive Officer Chanda Kochhar.
Industry was disappointed. The Confederation of Indian Industry (CII) said the central bank should now focus on boosting investments and growth rather than containing inflation. Assocham said: “We seem to have been caught in some kind of a vicious circle, which is taking a huge toll on growth.”
After the initial knee-jerk reaction, markets settled down following the central bank’s dovish guidance. Bond yields softened to close at 8.75 per cent, compared with the previous close of 8.77 per cent, while the BSE Sensex closed 0.12 per cent down.