Raghuram Rajan should be a worried man to see the July consumer price index (CPI) inflation at 6.07 per cent. That number is above the 2-6 percent target of the band agreed between the central bank and the government in early 2015 and is way above the RBI’s March, 2017 target of 5 per cent. But Rajan should be happy to see this number since it is a fitting reply to his critics who blamed him for not cutting the interest rates too fast and too sharply, said Madan Sabnavis, chief economist at Care rating agency.
Inflation remains too high to go for large doses of rate cuts. Rajan’s critics, including BJP MP Subramanian Swamy, had accused him for keeping rates high and ‘wrecking’ the economy. The persisting high retail inflation (the CPI has been increasing since April), in that sense, vindicates Rajan’s policy stance, Sabnavis said. A good part of the upward pressure on the CPI inflation is still emerging from food prices. The July numbers reflect this trend.
The CPI food index, in July rose from 137 to 138.8 (in percentage terms from 7.79 percent to 8.35 percent), the veg index rose to 165.5 from 159.7 (though percentage terms a tad lower at 14.06 percent from 14.81 in June). Similarly, pulses and products rose to 177.4 from 174.3 (in percentage terms 27.53 percent from 26.86 percent).
Analysts expect the food inflation to ease as the good monsoon will take effect from September onwards causing tapering of the overall CPI inflation. But, even then meeting the central bank’s March, 2017 target of 5 per cent will be a difficult exercise, thus prompting the RBI to go on a pause mode for a longer-than-anticipated period, said Indranil Pan, chief economist of IDFC bank.
“I think that a greater than 6 percent print is unlikely to sustain as this print was also on the back-drop of a base effect. Going forward, even as Headline inflation corrects lower, still the glide towards 5 percent by March2017 is not absolutely evident. Overall, this print is unlikely to change RBI’s monetary reaction function and RBI is likely to remain on hold for an extended period,” Pan said.
The RBI had left its key rate unchanged in last Tuesday’s bi-monthly review citing upside risks to inflation. Since January, 2015, the central bank has slashed the RBI’s key lending rate, repo, by 150 basis points. One bps is one hundredth of a percentage point. Though the inflation has considerably eased from the near double digit levels seen in 2013, it has shown an uptick in the recent months (from April to be specific). A good monsoon and base effect play would bring down inflation in the coming months, economists hope.
Recently, Rajan had taken on his critics on inflation debate challenging them to prove that inflation is lower enough to effect large rate cuts. “This discussion (on being behind the curve) keeps going on without any economic basis. You saw the CPI numbers just last week - 5.8 per cent is the CPI inflation, our policy rate is 6.5 per cent,” the governor had said at a function. When Rajan said this, June CPI was the latest available number.
Rajan asserted that he does not “really pay attention to this kind of dialogue”, said those calling him behind the curve should explain how inflation is very low to warrant lower interest rates. Rajan last month announced that he would step down at the end of his three-year tenure on September 4 and return to the academic world. Let’s be clear.
Inflation is the bigger evil in a country with sizeable chunk of poor and needs to be addressed first than anything else. The big relief is that the central bank now has an understanding with the government on the inflation-fight. Recently, the government agreed on the 4 percent (plus or minus 2 percent) CPI inflation target for the RBI till 2021, giving confidence to the monetary policy makers in the Mint Road to proceed with inflation addressing monetary policy measures.
Despite the expected easing in consumer inflation in post September, the 5 percent (March, 2017) and the subsequent 4 per cent (a year later) looks challenging for the RBI, according to economists. What this would mean is that the RBI’s future course of monetary policy will be filled with caution. Expecting large quantum of rate cuts in the foreseeable future wouldn’t be a wise idea. For Rajan, the current course of inflation offers evidence to show that he wasn’t off the mark on his policy assessment.