Incidentally, in the December policy statement, the RBI has explicitly stated that monetary measures need not always be announced on policy dates.

Much has been said about the unexpected hike in the repo rate announced by the Reserve Bank of India in the third quarter policy statement released on Tuesday last. The revised repo rate is 8 per cent. The general feeling is one of unpleasant surprise to many, among the vast majority, who were not anticipating any change.

After the announcement, however, there has been a greater equanimity. The stock markets have not responded as adversely as they would have in the face of an unexpected rate hike.

Besides, the surprise element has been integral to recent monetary policy announcements, and it is not something new to this policy statement. According to this view, RBI Governor Raghuram Rajan is not the first to announce monetary measures, which surprised the markets either in their timing or go against the grain of conventional wisdom.

Previous governors too have used the surprise element: announced measures outside the policy dates or gone against what the markets — as gleaned from surveys — think should happen. There have been instances even in the recent past when the central bank acted without notice, to put up, for example, interest rate defence for the falling rupee.

Incidentally, in the December policy statement, the RBI has explicitly stated that monetary measures need not always be announced on policy dates.

Those who subscribe to the surprise theory point to the fact that in the mid-quarter statement of December, the RBI was expected to hike the repo rate, but did not. There was enough justification in the form of high inflation, both CPI (Consumer Price Index) and WPI (Wholesale Price Index) to warrant a rate hike then. The reason why it held the rates then was well articulated in the December policy document. High vegetable prices were the prime driver of inflation, and there was every prospect of their softening before January. As it happened, inflation did come down on the back of a sharp fall in food prices, especially vegetables prices, giving rise to the expectation that the status quo will be maintained. That the RBI chose to mark up the repo by 25 basis points is the surprise.

Rationale for the hike

CPI inflation though less in December (the latest reporting date) is still high. More importantly, core CPI inflation (without food and fuel) has remained sticky at high levels. These two points were valid in December too. They suggested a rate hike even then. But the RBI did not act.

The clinching factor, therefore, lies elsewhere, and is to be traced to the implicit acceptance of the Urjit Patel committee report, which was released recently. The committee has suggested that price stability should be the predominant monetary policy objective, and that CPI inflation rather than WPI should be the rationale for rate action. The RBI should aim to bring down CPI inflation to within 8 per cent by 2014-15 and 6 per cent over the next 24 months. Perceptive analysts have pointed out that it is the first time that the RBI has projected an inflation path over a long period of two years.

For the record, the panel’s suggestions have not been accepted in toto. But, there is every indication that the RBI will take whatever steps which are within its domain, and consult the government for other steps to implement the panel’s recommendations. The immediate fall out is that by basing its rate action predominantly on CPI, the RBI has justified the repo rate hike. The RBI Governor has recognised the fact that the economic activity will slow down in the third quarter of this fiscal year. Yet, a rate hike was warranted because of persistent inflation. Over the long run, the two primary monetary policy objectives of maintaining price stability and supporting growth are not antithetical to each other.

If the central bank’s projections of inflation and growth are realised, there may not be scope for further rate hikes in the near future. However, it is well realised that for inflation to come down, monetary policy need to be supported by fiscal consolidation. The role of the new government after the elections will be critical.

narsimhan.crl@thehindu.co.in