Bold and pragmatic

The decision by the RBI not to hike the repo rate has come as a pleasant surprise to the market. The decision clearly emphasises the RBI’s concern to address growth the premise of food inflation rapidly cooling off from December and surprising the market by going against expectations. While the issues regarding weak growth are well known, I would rather highlight the other two others.

Even though consumer price index (CPI) and wholesale price index (WPI) numbers are at uncomfortable levels for November 2013, some clues provide comfort going ahead. The WPI trajectory will move down from December 2013 and the CPI should bring in more comfort, with the numbers possibly coming down to below 9 per cent by March 2014. For example, CPI core and CPI excluding vegetables for November 2013 are tracking at almost identical levels, implying the current surge is entirely driven by food prices.

Falling for good Our analysis also suggests the pace of decline in vegetables prices at wholesale mandis increased significantly from the fourth week of November 13, and this has continued into the first fortnight of December 2013. This will have a salutary impact on food prices in December 2013. Interestingly, the gap between provisional and final WPI may now reverse (so far the latter has been more than the former), pointing to a declining inflationary scenario.

I would like to relate the RBI’s decision to maintain status quo to the governor’s reference to William C. Brainard (

Uncertainty and the effectiveness of policy , 1967) in two of the latest policy conferences. This is a critique of the familiar Tinbergen’s rule which states that “there should be at least the same number of policy instruments as there are policy targets”.

However, Tinbergen principle works only in a world of certainty. The main thrust of Brainard’s argument is that in an uncertain world, multiple instruments can target a single objective. Brainard first shows that the optimal value of a policy instrument depends crucially on the use of more information than what policy makers may actually conceive (and hence the reference to December 2013 onwards inflation data by the governor). Interestingly, as Brainard argues, at times, it may actually pay for the policy maker to go the “wrong” way!

The monetary jigsaw Going by the several policy actions, in the last couple of months, Brainard’s surmise seems to hold. For example, in September 2013, the RBI took the market by complete surprise by hiking the repo rate.

In October 2013, it brought a significant chunk of oil demand back into the market, almost unnoticed. In November 2013, the central bank again took the market by surprise by announcing a new 10-year paper for auction, and now the status quo. Going forward, if the RBI goes for the “wrong/opposite way” on rate increases, don’t be surprised.

In sum, the jigsaw puzzles in monetary policy actions now seem to be falling in place. First, in July 2013, the RBI’s objective was to restore stability in the foreign exchange market, even at the cost of heightened volatility in financial markets. With the rupee falling in place from September onwards, the RBI now has shifted gears to fire-fight inflation. Perhaps, with inflation possibly being benign from December, next it may be a full-scale attempt by the RBI to reignite growth.

(The author is Chief Economic Advisor, State Bank of India. The views are personal.)