Raghuram Rajan: From an inflation hawk to a pragmatist

Three months on the job seem to have converted Reserve Bank of India Governor Raghuram Rajan from an inflation hawk to at least a pragmatist.

In a situation where the recent inflation numbers, whichever index one might prefer to look at, led to widespread expectations of a repo rate increase, the RBI chose to maintain the status quo.

The two previous increases in September and October served to reinforce the governor’s hawkish reputation, which was the basis of such expectations.

Evidently, it was believed that his commitment to controlling inflation was not in question, giving the RBI some space to accommodate the deepening concern about the slowdown in growth.

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This was said as much in the mid-quarter review statement, where reference was made to the negative output gap being one factor that would help to moderate inflation in the coming months.

The pragmatism showed up in references to the “weak state of the economy” and the “inadvisability of overly reactive policy action”. 

The main motivation for the surprise pause was the RBI’s apparent confidence in a rapid decline in food inflation, brought about primarily by sharp drops in vegetable prices.

There are early signs of this happening, which, if they persist, should vindicate the decision to stay on hold.

However, just in case anybody got the idea that this was the end of the tightening cycle, the statement was at pains to emphasise that there would be a response to any indication that the expected softening was short-lived and, further, that this response could come at any time.

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This creates the impression that, if the January inflation readings are not in line with these expectations, the repo rate could be raised on January 14 or 15, two weeks before the scheduled quarterly review and soon enough not to threaten the institution’s inflation-fighting credentials.

That eventuality may or may not materialise. What is significant about this unexpected pause, however, is the admission that, however strong the commitment to containing inflation may be, there is an element of futility to responding to inflation without any end in sight.

The foundation of contemporary monetary policy frameworks is the importance given to inflationary expectations and the need to keep them in check. Since inflationary expectations in India appear to be predominantly influenced by food prices, higher food inflation did provide a justification for a rate hike.

The only rationale for not increasing the rate now was that the recent spurt in food inflation was going to be short-lived. That rationale was explicitly used, but the qualifiers made it quite clear that the confidence in it was not very high.

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Food inflation, which has been painfully high for six years with rare episodes of respite, is not going to trend down so easily.

While the decision to pause in this mid-quarter review may not be very significant in the fight against inflation, the longer-term dilemma about how exactly to deal with the situation without completely stifling growth needs to be resolved, and quickly.

The new monetary policy framework due to be announced by the end of this month may provide a compromise.

But, ultimately, as has been repeatedly asserted, the solution lies in lifting agricultural productivity, initiatives for which will have to wait for a government with a vision.