Pacific Money

Reserve Bank of India Raises Key Rate

After a euphoric welcome, India’s new RBI chief has delivered a dose of reality, raising a key interest rate.

Less than two weeks ago, Pacific Money commented that Raghuram Rajan, India’s newly installed chief of the Reserve Bank of India (RBI) – the central bank – had been greeted with a near euphoria by financial markets. Now, a dose of reality has been administered by the man who then claimed that he held “no magic wand”: In a surprise move, the RBI has hiked its key policy repurchase interest rate by 25 basis points, from 7.25% to 7.5%.

Back when he took up his position, the overriding and most immediate concern for the Reserve Bank of India was the ongoing collapse in the value of the rupee, one of the worst performing currencies in the world this year. Rajan’s big bang arrival gave confidence back to the currency, and markets breathed a partial sigh of slight relief…

…Until inflation data came in for August.  India has two inflation indices. One is the Wholesale Price Index (WPI), which showed August inflation climbing to 6.1% year-on-year (YonY). Meanwhile the Consumer Price Index (CPI) recorded inflation at 9.5% YonY, down slightly from July.  Grabbing the headlines though (and indeed providing much ammunition for headline writers), was a staggering hike in the price of onions – whose WPI reading climbed 245% YonY.

Despite these high inflation figures, there was still little expectation that Rajan would actually raise rates. Yet on the heels of the Fed’s unexpected failure to begin its “taper,” Rajan delivered his own little surprise and performed a tiny bit of tightening of his own. Both the currency and India’s stock market met the news with a slight dip, but both have recovered somewhat at the time of writing. It should be noted though that the tightening rate rise was offset somewhat by other loosening measures including a cut to the Marginal Standing Facility rate and to the minimum daily Cash Reserve Ratio (CRR) balance that banks have to maintain.

Rajan’s focus on inflation was highlighted in his statement, and he also elaborated on his hopes for preserving “…the internal value of the rupee…”; returning the country to “normal monetary operations”; and returning the repo rate to its role as the “effective policy rate.”

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Also significantly, Rajan laid out his plan to take advantage of the postponement of the Fed’s tapering.  His statement stresses that the reprieve must be seized as an opportunity to strengthen the Indian “national balance sheet and growth agenda,” which will boost confidence in the country and presumably make the side-effects of the “taper” more bearable for the Indian economy.

As mentioned previously in this blog though, a lot of the responsibility for “seizing” this opportunity lies not on the shoulders of Raghuram Rajan, but with the government. So while Mr Rajan continues to impress in his role, it is on the latter where the spotlight will increasingly fall.