Millennium Post

Banking on his Raghulation

Banking on his Raghulation
Reserve Bank Governor Raghuram Rajan has again belied expectations, this time with a repo rate hike of 25 basis points, instead of a pause, to push the key lending rate to eight per cent, in the context of both WPI and retail core inflation (excluding food and fuel) remaining high while aggregate demand pressures are imparting upside risk to overall inflation.

Further, Rajan has taken note of a slowdown under way in China and the ‘uneven and subdued’ recovery in euro area and Japan. Without mentioning India as such, he said uncertainty surrounded prospects for ‘some emerging economies’ where, he said, domestic fragilities were getting accentuated.

Thus, he saw a financial market contagion also as a ‘potential risk’, apparently referring to a day of volatility in global financial markets on 27 January, gripped by fears of increased Fed taper and sell-offs. India’s markets also crashed and the stock indices fell two per cent and the rupee plunged below 63 to a dollar. ‘It is critical to address these risks to the inflation outlook resolutely in order to stabilise and anchor inflation expectations’, even India’s economy is weak and substantial fiscal tightening is likely in Q4’, the Governor said in his Third Quarter Review of Monetary Policy for 2013-2014 on 28 January.

Rajan left the Cash Reserve Ratio (CRR) unchanged at four per cent while as a result of the repo rate hike by quarter percentage point – from 7.75 to eight per cent -  the reverse repo rate would be seven per cent and the marginal standing facility (MSF) and Bank Rate (BR) would be nine per cent each.

On policy stance and rationale, Rajan said CPI inflation excluding food and fuel has remained flat and WPI inflation excluding food and fuel has risen. An increase in the policy rate would therefore be consistent with the guidance given in the Mid-Quarter Review but also would set the economy ‘securely on the recommended disinflationary path’. The extent and direction of further policy steps would be data dependent, though if the disinflationary process evolves according to this baseline projection, further policy tightening in the near term is not anticipated at this juncture, the Governor indicated.

But the next policy review would only be on 1 April 2014, making a departure from the mid-quarterly reviews. The Governor has decided, acting on the recommendation of the Urjit Patel Monetary Policy Committee, that hereafter the reviews would ordinarily be undertaken in a two-monthly cycle consistent with the availability of key macroeconomic and financial data.

The Governor’s review does not envisage, at this juncture, any substantial moderation in CPI inflation or stronger GDP growth for fiscal 2014. On the likely trajectory of inflation till January 2015, RBI’s baseline projections in the Third Quarter Review of Macro-Economic Developments for Q3 of 2013-2014 indicate ‘upside risks’ to the central forecast of eight per cent CPI inflation. The Patel Committee has set a CPI inflation target of eight per cent, which should lower below eight per cent by January 2015 and below six per cent by January 2016.

Again, on GDP growth, the Governor said if policy actions succeed in delivering the desired inflation outcome, real GDP growth can be expected to firm up ‘from a little below five per cent in
2013-2014 to a range of five to six per cent in 2014-2015, with risks balanced around the central estimate of 5.5 per cent’.

 Any upside (enhanced growth) to this forecast would depend on a pick-up in investment in an environment in which external demand continues to be supportive of export performance, he said.
Current account deficit (CAD) for 2013-2014 is expected to be below 2.5 per cent of GDP as compared with 4.8 per cent in 2012-2013, according to RBI. The recent resumption of portfolio flows, both equity and debt, alongside the pick-up in FDI and external commercial borrowings that is underway should help finance the current account deficit comfortably. Reserves have been rebuilt since September, the Governor said. On growth in 2013-2014, the Third Quarter Macro-economic Review says, on current reckoning, it is likely to fall somewhat short of RBI’s earlier projection of 5.0 per cent. However, a ‘moderate paced’ recovery is likely to shape in 2014-2015 with support from rural demand, a  pick-up in exports and some turnaround in investment demand.

The growth in 2014-2015 is likely to be in the range of five to six per cent. The higher reach would depend on project clearances translating into investment and improvement in global growth outlook along with softening of inflation. Growth in current year is expected to be less than five per cent as industrial activity stagnated and non-food inflation had risen in December. That inflation remains the daunting challenge is clear from the RBI Policy Statement and the Macro-Economic Developments Review. Though some further softening in line with the December index is expected in the near term, inflation risks have to be watched as the economy enters into next fiscal year. This is due to upward revision in domestic energy prices, expected growth acceleration, structural bottlenecks affecting food inflation and adverse base effects, the review said.

Headline CPI inflation is expected to remain above nine per cent in Q4 of 2013-2014 (January-March) and range between 7.5 to 8.5 per cent in Q4 of  2014-2015, with the balance of risks tilted on the upside. This underlines the risks for growth over the medium term.

Overall, not a reassuring picture from Raghuram Rajan in the Third Quarter Review. The battle against inflation would go on but, to succeed, would need huge actions on the government side and in conditions the country is passing through among the toughest since independence. The new government that may be ushered in, if stable, would have a Herculean task to re-set the economy on a more sustainable growth path.

Clear signs of a pickup are yet to emerge though a modest recovery is likely to shape up in 2014-2015. Durable recovery remains contingent on addressing persistent inflation and the bottlenecks facing the mining and infrastructure sectors, the Review added.

IPA

S Sethuraman

S Sethuraman

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