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: