6% inflation target in 2 years will raise interest rates: Experts

Interest rates are likely to move higher as the RBI’s expert committee on strengthening monetary policy framework has recommended that the central bank target consumer price index-based inflation of 6 per cent in the next two years.

The Reserve Bank of India will formally adopt the nominal anchor or the target for inflation, which will be set at 4 per cent with a band of +/-2 per cent around it, once the CPI inflation comes down to 6 per cent.

“Clearly, interest rates will move higher (if the report is implemented). The report does signal toward a fairly upward bias in interest rates and this can be damaging for growth,” said Abheek Barua, Chief Economist, HDFC Bank

Crisil Research in a report said, “If the RBI accepts the recommendations of the Urjit Patel Committee, interest rates are unlikely to come down in 2014-15 even if the RBI removes its current restriction on bank borrowing through the repo window.”

Late Tuesday evening, the expert committee set up to revise and strengthen the monetary policy framework, said the RBI will try to bring down inflation gradually from 10 per cent to 8 per cent over the next 12 months and to 6 per cent over the next 24 months before formally adopting the recommended target of 4 per cent inflation with a band of +/-2 per cent around it.

The committee has also advocated that the real policy rate should be positive, implying that the repo rate (currently at 7.75 per cent) should be higher than the expected CPI inflation (expected to average around 8.5 per cent in 2014-15).

In other words, there is little scope for monetary policy to boost growth in 2014-15.

Any recovery in investments, therefore, will be largely driven by the clearance of stalled projects, Crisil said. Shubhada Rao, Chief Economist at YES Bank said, “Inflation at 8 per cent in 12 months is doable, though larger Government action is definitely warranted.

“However, the report is a step in the right direction as inflation leads to distortion of facts, such as savings behaviour, investment decisions and export competitiveness. Hence, bringing down inflation cannot be debated for growth.”

According to Barua, “As a long-term framework, it (report) makes sense. But in the shorter term, we need more discussion-based rather than strict rule-based monetary policy.”

He added that the committee report is more a vision document and the structure is contingent on other factors, such as growth and supply-side bottlenecks.

“We could rightly see some dilution in the timeframe for its implementation,” he said.