Money & Banking
By not hiking rates, the RBI has merely postponed the inevitable, says BNP Paribas

With inflation expectations still on an upward arc and the RBI admitting that core CPI inflation is too high, today’s decision probably only delays the inevitable, says BNP Paribas in its research note

RBI (Reserve Bank of India) Governor Rajan sprang another surprise at his third meeting in charge by eschewing a further rate hike despite recent appalling inflation data, remarks BNP Paribas in a research note on the RBI policy announcement. The policy statement makes clear that today’s decision was a ‘close one’ and that further tightening is still forthcoming if inflation gauges do not show immediate improvement next month from November’s elevated readings.


With inflation expectations still on an upward arc and the central bank admitting that core CPI (consumer price index) inflation is too high, today’s delay probably only delays the inevitable and increases the risk of more aggressive tightening next year, warns BNP Paribas.


BNP Paribas criticises RBI policy by saying, “With GDP growth still under pressure given industrial production’s softness in October and still depressed survey indicators, the temptation is to try to look through the latest disruptive spike in food inflation and argue that a pull-back is simply a matter of time. Inflation is on the cusp of a decisive retreat to more acceptable levels.”

BNP Paribas points out that patience can be a virtue but prevarication is a vice, at least in the realm of monetary policy. By not tightening monetary policy, Governor Rajan is quickly succumbing to the admittedly complex web of pressures that bedevilled and ultimately undermined his predecessor’s stewardship, argues the research note.



The research note gives its own solution to the problems as, “Given the concerning trend in inflation expectations, not to mention the uncertainty facing India from a possible earlier than expected ‘tapering’ of asset purchases by the US Federal Reserve, today’s decision likely only delays the inevitable and impedes the long and painful process of re-anchoring inflation expectations and firmly establishing central bank credibility!”


The research note argues that Dr Rajan’s first two Policy Reviews had signalled a clear break with the past with RBI transitioning to a clearer, more hawkish reaction function. Today’s decision throws this into question.


In conclusion, BNP predicts, “We continue to target a 25bp rate hike either following the December inflation data released in mid-January or at the scheduled 28th January Policy Review. Our inflation forecasts suggest a further 25bp may be needed after that as well.”


BNP Paribas’ warnings on inflation and the need for firm action by RBI are clear from the following charts:



RBI keeps repo, CRR, and other key rates unchanged

While keeping key rates unchanged, the RBI said given the wide bands of uncertainty and weak state of the economy there is merit in waiting for more data

The Reserve Bank of India (RBI), in its mid-quarter credit policy review has kept repo, reverse repo, cash reserve ratio (CRR) and bank rate unchanged. The central bank said the policy decision is a close one as current inflation is too high. "However, given the wide bands of uncertainty surrounding the short term path of inflation from its high current levels, and given the weak state of the economy, the inadvisability of overly reactive policy action, as well as the long lags with which monetary policy works, there is merit in waiting for more data to reduce uncertainty," RBI said in the policy statement.


According to RBI, there are obvious risks to waiting for more data, including the possibility that tapering of quantitative easing by the US Fed may disrupt external markets and that the Reserve Bank may be perceived to be soft on inflation.


"Even though the Reserve Bank maintains status quo today, it can help guide market expectations through a clearer description of its policy reaction function: if the expected softening of food inflation does not materialise and translate into a significant reduction in headline inflation in the next round of data releases, or if inflation excluding food and fuel does not fall, the Reserve Bank will act, including on off-policy dates if warranted, so that inflation expectations stabilise and an environment conducive to sustainable growth takes hold," the central bank said.


With no change in key policy rates, the repo rate (the rate at which the RBI lends money to banks) remains at 7.75%. Similarly reverse repo rate (the rate at which the RBI borrows from banks), CRR, and bank rate remains at 6.75%, 4.00% and 8.75%, respectively.


Repo Rate.......................7.75%


Reverse Repo Rate..........6.75%




Bank Rate......................8.75%


RBI is not soft on inflation, claims Dr Raghuram Rajan

RBI Governor Dr Raghuram Rajan has assured that he will act outside policy if inflation does not soften in a press conference on 18 December 2013

RBI (Reserve Bank of India) has kept repo rate unchanged at 7.75% and CRR unchanged at 4% in its 18th December policy meeting. In a press conference following this announcement, RBI Governor Dr Raghuram Rajan made it clear that he was not soft on inflation and that he will act outside policy, if inflation does not soften. It is felt that inflation as per current data looks higher because of the rise in vegetable prices and these are likely to come down. In this context, Dr Rajan indicated, “We will not react to every spike in inflation, which is temporary. We as responsible central bankers will react to longer term phenomena.”


Dr Rajan said the RBI will wait for more inflation data to come in to make up its mind whether inflation was well-entrenched and called for higher rates. The current inflation data is marred by noise, he said. In a month’s time the inflation picture in the country will become clearer and RBI will tighten policy if required to control inflation. Dr Rajan was clear that there was no room for complacency on CPI inflation.


Dr Rajan also pointed out that this was the correct policy in a weak economic environment. He admitted that while inflation could be caused by supply bottlenecks, the RBI would have no option but to control demand even if supply-driven inflation persisted.


Dr Rajan argued that the RBI policy was not the sole controlling factor in inflation. Central and State governments in the country will be working on inflation, and RBI will take a decision after the government has improved matters. This is because inflation was even now stable excluding food and fuel.


On the growth-inflation issue, the RBI governor forecasted that GDP growth will be higher in the second half of FY2014. Also, the government is firm on achieving the fiscal deficit target by March 2014. Revenue from disinvestment will help in doing so. The exchange rate of the rupee has stabilised and the current account deficit position is under control.


On NPAs (non-performing assets), Dr Rajan said that there will be an appropriate circular in two weeks. Finally, Dr Rajan added that the curbs on borrowing from LAF (liquidity adjustment facility) will continue to exist.


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