Bitter medicine

RBI Governor Raghuram Rajan’s proclivity towards squashing market expectations through hardened monetary policy stances is on show again.

Though core inflation in December has eased, the apex bank’s decision to raise the repo rate by 25 basis points to 8 per cent is aimed at restraining WPI and CPI inflation at current levels at least till the end of the fourth quarter of 2013-14 to enable the government to meet its fiscal and current account deficit targets. Hence, meeting the anticipations of the market is secondary, though a further increase in lending rates will put pressure on overall demand and make credit costlier by 12 per cent even for larger corporates, just when the industry is showing signs of rebound.

The Urjit Patel committee had in its recommendations last week mandated guiding of CPI to below 8 per cent by January 2015 and this has been a factor RBI takes seriously, when it has begun the process of benchmarking economic growth against CPI inflation. Rajan is also emphasising on bringing down CPI readings to 6 per cent over the next year, and this could placate industry -- which want a respite from repo cuts going ahead. However, corporate investment to GDP has slumped from post-2007 crisis levels of 17.3 to 10.6 per cent; it is likely that low productivity conditions will continue, coupled with runaway demand for credit leading to an investment cul-de-sac exacerbated by a high interest scenario. Moreover, any slackening of food inflation is likely to be momentary despite the good monsoon, given the vagaries of the rabi crop and inadequacies of the supply chain and warehousing systems exacerbating wastage and causing demand crunches, not to mention widespread black-marketing and hoarding sparking of flash surges in vegetable prices.

The above factors remain prime concerns worrying RBI, though in this round of monetary policy it has actually softened its aggressive stance of December, by revealing its intentions to put repo rates on hold in the coming months. While higher interest rates have tended to negatively impact foreign equity inflows and the rupee, the fact is that if inflation declines in line with RBI’s projections, further policy tightening will likely not be necessary and purchasing power can be maintained on an even keel. This is likely if more FDI inflows happen as the government expects which can also help maintain the rupee at a stable rate of around 61. Therefore, there is room to be positive on the latest lending rate hike.