The RBI will not react to every spike in inflation with a rate hike, especially in a slowing economy, says governor Raghuram Rajan. In an interaction with the media and analysts, Rajan says the central bank continues to be vigilant on the inflation front:
How should we read your policy today? What should we expect when the CPI is 10.5% and when it?s 10%?
It is important to resist from labels like ?dovish? and ?hawkish? here. We are trying to calibrate monetary policy, primarily to target inflation in an environment where the economy is weak. So, when we take action, we have to be convinced that it has merit. We want to wait for more data. I can?t tell you that if inflation is at ?x?, we will raise the rates by ?y?. It is not based on one particular indicator. We need to see a substantial softening of headline inflation as well as momentum in the right direction.
How concerning is growth slowdown? Would the next GDP and IIP numbers be as important as inflation?
Certainly, we will look at the growth numbers. Our sense is that growth is below potential even now and this extent of negative output gap should be seen in the inflation numbers. If the transmission is not taking place, we have to question our assumptions and that would be an important factor as well.
Given recent IIP and other numbers, are you still confident of a pick-up in H2?
We believe growth in the second half will be stronger. Of course, there are factors like agriculture, exports and revival of stalled projects. It is important that government and RBI remain vigilant. Give or take a few basis points, we are standing by our projections.
Is the RBI happy with the kind of monetary policy transmission that has happened so far?
When the RBI cut rates, these were not transmitted. So, there seems to be a certain amount of lag in these things or a lack of response. Going forward, we will have to calibrate policy to circumstances.
Your concerns on fiscal deficit?
The government has reiterated its commitment to the fiscal deficit target. My own sense is that the government is firm on achieving it and will do so by March end. That would mean a certain amount of expenditure contraction in Q4 and that would mean some impact on growth. An increase in disinvestment and greater revenues from companies would help achieve the fiscal deficit.
Is it that the RBI would not act whenever food prices rise again?
You should not read it that way. What we are saying is that we will not react to every spike in inflation that is temporary. Monetary policy, after all, operates with long lags, that is 3-4 quarters. So, whatever we do now is affecting output a few quarters down the line. So, we have to be sure that whatever is happening is longer term phenomena.
You said raising rates would have been overly reactive. What did you see so overwhelming on growth side to make you pause?
The point that we were trying to make is that we shouldn?t react to every rise in inflation if that inflation is going to come down. If we set the level of policy consistent with 11.24% on CPI and, suppose, it came down to 9% next month, would we then react to that 9% and change policy rates? We are vigilant for the possibility that food inflation may be more entrenched; we are not ignoring food inflation. But we would like to see through the noise and for that we want to wait a month more. This is not in any way changing trade-offs between growth and inflation. This is saying that as responsible central bankers, in an environment of weak economy, we have to try and see what the underlying strength of the inflation is. We will calibrate the level of the policy rate consistent with what we see as the underlying inflation rate.
Has CAD moved down your priority list now?
On the external environment, we cannot afford to be complacent. We are in a better position now to withstand once the tapering begins. We have shown the ability to raise money. If we look at FII numbers, we are a negative $2 billion. There were outflows until late November but early December, we have started seeing inflows.I don’t think anybody in the world, including the Federal Reserve, knows the consequences of taper. Whether it is tomorrow, or next month or the month after, it has to happen. We should aim for having a CAD without any distortions or significant curbs. But at this point, I feel very comfortable with the level of CAD.
