THE RBI has raised the repo rate by 25 basis points in its policy announcement. It is trying to be a credible inflation-targeting Central Bank. If the inflation rate rises above the optimum point, the Bank’s credibility sags. Interest rates are then kept low. The Urjit Patel Committee has recommended that the RBI should focus on a Consumer Price Index (CPI) inflation which is what people care about. RBI governor Raghuram Rajan is considering the recommendation as the wholesale price inflation is not to the point. The RBI is likely to adopt the Urjit Patel Committee’s CPI inflation target of 8% to be achieved by January 2015. It is regardless of whether the Committee Report is formally adopted. But will it lower inflation? Hopes are raised by the Central Bank’s tightening and fiscal contraction expected in the January-March quarter. It is hoped that the rate-hike cycle will then come to an end.
The RBI’s policy often springs a surprise on the market. It is of course an important part of monetary policy. The repo rate was unexpectedly not hiked last time. Though growth forecasts appear weaker, the rate has now been hiked. That makes RBI policy somewhat nebulous. Soon enough however the market should be able to respond to RBI signals. Inflation is there and the market does not wait for the announcement of RBI policy. The coming parliamentary elections also have an impact. The market moves when data on employment or inflation come out. It can then anticipate RBI reactions. Rajan seems to be moving towards such a systematized process.
