RBI policy: Raghuram Rajan faced with a close call, yet again

Anand Adhikari

"I would say again the decision was close. Last time it was close but we chose to wait. This time it was close but we chose to act (by hiking the repo rate)."

Reserve Bank of India (RBI) Governor Raghuram Rajan made the first statement in his December 19, 2013, monetary policy review, and the second on January 29 this year when he increased the central bank's main lending rate to 8 per cent from 7.75 per cent. Rajan is once again faced with a close call - whether to cut rates or maintain status quo.

Market observers widely expect Rajan to stand pat on interest rates on April 1 when the RBI holds its first bi-monthly monetary policy review for the financial year 2014/15.

The RBI, if it holds rates, will have to make a strong case for an increased upside risks to inflation. Core inflation - which excludes food and fuel - could be a spoiler in the softening of interest rates, as it has inched up from 3.0 per cent in January to 3.15 per cent in February.

But there is also encouraging data that calls for a token reduction of 25 basis points.

The rupee has risen against the US dollar since September when Rajan came in as the new RBI Governor. The local currency has bounced back above 60 versus the greenback compared with 69 about seven months ago. The threat of inflation seeping in through high imports, especially of crude oil, has receded. The current account deficit (CAD) has been contained, which gives comfort that any further reduction in quantitative easing by the US won't impact the rupee much.

Also, both the consumer price index (CPI) and the wholesale price index (WPI) have been on the decline. The WPI eased to 4.68 per cent in February from 5.05 per cent the previous month while the CPI fell to 8.1 per cent from 8.79 per cent thanks to cheaper food items, which has been a major concern in the past. The CPI is now close to the RBI's targeted level of eight per cent by March 2015.

A report by an RBI-appointed committee headed by Urjit Patel had recently talked about a "glide path" to bring inflation below 8 per cent by March 2015 and below 6 per cent by March 2016.

In its January monetary policy review, the RBI had said its own baseline projections indicate that over the ensuing 12-month horizon (and with an unchanged policy stance), there are upside risks to the CPI forecast of 8 per cent by March 2015. The rate hike in January was aimed at putting the economy on the recommended path of lower inflation.

Those in favour of a rate cut say, however, that the RBI's mandate is not just to control prices but also to encourage growth, a view reiterated by Finance Minister P Chidambaram time and again.

Economic growth crawled at 4.7 per cent in the quarter through December and industrial activity has been contracting because of a slowdown in demand. A leading rating agency has warned that any interest rate hike by the RBI will push more companies into the default zone. Rajan must keep these factors in mind as well when he makes his decision.