Why Raghuram Rajan hiked the repo rate

In the December monetary policy review, the Reserve Bank of India (RBI) Governor Raghuram Rajan had decided against a rate hike. "The decision was a close one then," Rajan told reporters in Mumbai.

Rajan was waiting for food prices to cool down. That did happen and the wholesale price index (WPI) inflation fell from 7.5 per cent in November to 6.2 per cent in December. The consumer price index (CPI) inflation dropped from 11.16 per cent to 9.87 per cent in the same period.

In the latest review of the monetary policy , it was again a tough decision for Rajan but he finally opted to hike the repo rate. Why? "We still have some aspects of inflation sticky and not moving ( down)," Rajan said. "That is suggesting we probably need some medicine. We have injected some medicine now," he adds.  

Rajan is actually referring to retail inflation, the CPI excluding food and fuel, which has averaged 8.1 per cent in 2013/14.  This forced the RBI to hike the repo rate by 25 basis points to 8 per cent. Housing and transport & communication have been the two biggest contributors to non-food, non-fuel CPI inflation. Services is yet another big contributor, particularly education and medical care.  Rajan wants to rein in these elements of inflation.

The Governor is also guided by the Urjit Patel Committee report which has talked about a road map for reducing CPI inflation to 8 per cent by 2015 and 6 per cent by 2016. At 9.87 per cent, CPI inflation is way above the RBI's comfort zone of four per cent. "The policy indicates that if inflation moves as expected, further tightening would not be required in the near term and any easing of inflation beyond the current projection may allow for a more accommodative monetary policy," says Chanda Kochhar, Managing Director and CEO,ICICI Bank.