Rate hike deferred expect lower rupee

Rate hike deferred expect lower rupee

Time to exit targeting food-intensive CPI?

The Reserve Bank of India (RBI) has decided to surprise the markets by holding the repo rate unchanged, instead of raising it by at least a quarter of a percentage point as widely expected. In the wake of one round of policy rate tightening by the US Fed and before one more round of tightening in the US, in the midst of trade and geopolitical tensions that trigger currency volatility, a policy rate hike would have been natural to arrest the rupee’s slide — it has moved down some 7% in the last two months. Perhaps RBI wants the rupee to move down a little more. After all, the current account deficit has not yet stabilised: it is widening still, meaning that rupee depreciation has scope to compress imports further.

The overt reason for RBI to hold its policy rates, while shifting gears, in its monetary policy stance, from neutral to calibrated tightening, is that inflation is turning out to be tamer than it had anticipated earlier. Benign rains and bountiful harvests, along with dissipating effects of the government’s release of enhanced house rent allowance for its employees, have kept the rise in the consumer price index (CPI) moderate, with the government’s tax forgiveness and administrative paring of oil marketing company margins more than compensating for the rise in oil’s rupee-equivalent price, to moderate retail prices of petro-fuels. This newspaper has always questioned the wisdom of monetary policy being guided solely by inflation as measured by the consumer price index. Turbulence in global stock and commodity markets and one-way shifts in currency flows in the wake of reversal of quantitative easing increasingly put pressure on the rupee. Should monetary policy not address this?

The Monetary Policy Committee is mandated to take these into account only via their impact on inflation, as measured by CPI. A weaker rupee raises the cost of imported capital goods and other inputs, ignored by the CPI but harming exports. In a globalising economy, fiscal, monetary and capital flow changes determine growth and stability. It would make sense to dump the synthetic simplicity of inflation targeting in monetary policy.