10/13/2014

The Economic Times

Title : Guest Column - RBI in No Mood to Abandon Fight Against Inflation
Author : RADHIKA RAO Economist, DBS Bank
Location :
Article Date : 10/01/2014
The Reserve Bank of India stuck to its neutral tone on Tuesday, extending its status quo on the
benchmark rates. The central bank is unlikely to abandon its anti-inflationary stance in haste, before
any lasting improvement in the inflation outlook.
Admittedly, the CPI inflation trajectory is on track to meet the early-2015 target of 8%. But the
disinflationary path will not be a straight line. There will be considerable swings in the readings
between October and March 2015, influenced by base effects (due to last year's exchange rate and
vegetable price shocks).
Alongside the base effects, the recent moderation in perishable food prices is also expected to add to
the initial downswing in CPI readings until December. But this effect will wear off into March 2015
and CPI may inch back towards 8% notwithstanding the tame food prices. Against this backdrop, the
RBI will be reluctant to over-react to single data-points and is likely to keep the repo rate unchanged
until end fiscal year 2015.
Meanwhile, the markets continue to build rate cut expectations, even in the face of a cautious central
bank. The RBI, in fact, signalled its hesitance to lower rates by shifting focus to the early-2016 target
of 6%, after the 8% goal looked within reach. The move to shift the goalpost, we believe, reflects the
RBI's serious view on moulding inflationary expectations and affirming its inflationfighting
credibility.
In case the RBI cuts rates in response to slightly sub-8% inflation, it is inadvertently conveying to the
markets that it is comfortable with the present price outlook. Instead, by bring ing in the 6% target in
view, the central bank has emphasised that the fight against inflation is not over yet. We also believe
that rather than being fixated at the nominal target, the RBI will also be mindful of the disinflationary
path and the underlying drivers.
A combination of recent domestic and external drivers has calmed inflation concerns, but not all are
driven by structural improvements. Firstly, the significant moderation in the international fuel prices
has reduced the scale of increases needed in the subsidised fuel prices. But the decision to completely
deregulate diesel pricing is yet to be taken up.Secondly, even as the monsoon deficit has narrowed
sharply, the skewed distribution of the rains could emerge as a pipeline risk for food prices over the
next two quarters. Contained increase in the minimum support prices, meanwhile, was a timely move
to contain foodgrain prices.
Thirdly, subsidy rationalisation plans are yet to be outlined to back the fiscal consolidation plans. If
the optimistic revenue projections and growth turnaround do not materialise, the deficit situation is
likely to turn worrisome later in the year and require cutback in capital expenditure to meet targets.
Next, concerns over the narrowing output gap (into FY16) and the prospect of higher aggregate
demand feeding into inflation also warrant attention.
Finally, volatility is likely to heighten as the markets price in US rate hikes. Even as the USTs and
Indian rate differentials are wider than the long-run averages, we believe the RBI will be wary of
lowering policy rates in the face of higher US rates.
To sum it up, easing inflation is positive for the economy, but we are some distance away from
reaching RBI's comfort levels. Until a sustained downtrend towards CPI at 6% is achieved, the RBI is
likely to keep rates on hold until endFY15 and beyond.
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