India: Central Bank raises monetary policy rate
January 28, 2014
At its 28 January monetary policy meeting, the Reserve bank of India (RBI) decided to hike the repurchase rate from 7.75% to 8.00%. The decision came in as a surprise to most market analysts who had expected monetary authorities to leave interest rates unchanged. However, the market had recently begun to expect a rate hike after the Urjit Pattel committee submitted a report in which it made recommendations for reforming the Bank's monetary policy framework. The report makes a variety of recommendations, including using the consumer price index (CPI) instead of the wholesale price index (WPI) as the anchor for monetary policy.
According to the Bank's statement, signs of improvement in the global economy, which is mainly buttressed by healthier grown in the U.S. economy, are visible. Nevertheless, the Bank underlined the persistence of downside risks to global growth, which come mostly on the back of slower growth in emerging economies. Domestically, the RBI stated that growth has likely lost momentum during the third quarter of the 2013/2014 fiscal year, which is mainly due to a deterioration in industrial production. In addition, the Bank pointed out that growth in private consumption remains weak and, "lacklustre capital goods production points to stalled investment demand."
Regarding price developments, monetary authorities acknowledged that, despite the recent moderation seen in both headline WPI inflation and in CPI inflation (particularly in prices for fruits and vegetables), CPI inflation remains high and close to double-digit levels. The Central Bank, therefore, claimed that its monetary policy decision is critical to addressing upward risks to inflation expectations, while also recognizing that that the economy is still weak. Accordingly, the RBI revised its growth forecasts for the 2013/2014 fiscal year to, "a little below 5.0%," versus the previous 5.0%. If inflation continues to moderate, the Bank expects growth to increase to between 5.0% and 6.0% in fiscal year 2014/2015. Meanwhile, the Bank sees CPI inflation above 9.0% in Q1 2014 and, while it expects CPI inflation to fall to between 7.5% and 8.5% in Q1 2015, it does see upside risks to its forecasts.
The RBI concluded that its decision was in line with the guidance it gave at its last meeting. It also added that, "the extent and direction of further policy steps will 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." In addition, most analysts agree that the Central Bank has essentially endorsed the Urjit Pattel committee's recommendations to make the CPI index the Bank's policy target. FocusEconomics panelists project that the repurchase rate will average 7.58% at the end of fiscal year 2014/2015. For fiscal year 2015/2016, panelists see the repurchase rate ending at 7.44%.
Author: Ricardo Aceves, Senior Economist