India: RBI : Inflation: A New Goal

British Deputy High Commission Mumbai

January 2014


Contrary to market expectations, the RBI raised the benchmark repo by 25bp to 8%, but issues a clear message that this is unrelated to global contagion. Most market players expected a pause in tightening after a significant decline in headline inflation in December. As a first to step to apply the recommendation of the Urjit Patel committee on monetary policy, CPI deemed the nominal anchor and forward guidance set on the basis of the recommended reduction in CPI to 8%  by next January. Further rate hikes are unlikely unless inflation strays significantly from the expected path.


Consumer Price inflation (CPI) declined from 11.2% in November to 9.9% in December.WPI inflation declined from 7.5%  to 6.2% in the same period  while industrial production contracted 2% in November. These factors led markets to expect a  pause in the rate cycle. At its December meeting, the RBI indeed paused attributing  the spike in inflation to fruits and vegetables which would eventually decline. However future action was made conditional on a softening of food inflation translating into a significant reduction in headline inflation and softening of inflation excluding food and fuel.

 The January policy statement pointed out  that while CPI declined significantly on account of the anticipated disinflation in vegetable and fruit prices, it remains elevated. Moreover, core inflation (excluding food and fuel) has also been high, especially in respect of services, indicative of wage pressures and other second round effects. Services inflation particularly health care, education and housing remains significant. Core WPI (WPI excluding food and fuel) also recorded an uptick in the same period.

The Governor  was non-committal on the complete adoption of an inflation targeting framework, but explicit that inflation as understood by the common man was important for the RBI. This underpins the shift to the use of CPI as the basis for monetary policy. He insisted that there is no trade–off between growth and inflation at this juncture, as stable inflation is key to growth.

The Urjit Patel Committee indicated a “glide path” for disinflation that sets an objective of below 8% CPI inflation by January 2015 and below 6% CPI inflation by January 2016.  The RBI has committed itself to bringing down inflation to 8% over the year. Foreseeing  upside risks to the central forecast of 8%, the RBI believes  that an increase in the policy rate will set the economy securely on the recommended disinflationary path. The extent and direction of future policy steps will be data dependent,  however if the disinflationary process evolves according to this baseline projection, further policy tightening is not anticipated. 

Governor Rajan insisted that the rate hike was not a  response to financial contagion from emerging markets. The decision would have be the same even in the absence of an emerging market selloff. The RBI intended to protect the value of the rupee, domestically and internationally. This meant controlling inflation.

The Governor reiterated that the RBI remained vigilant not complacent, but  would  not overreact to short term movements.  The RBI and the government are in a much better position now , than during the summer. The Governor pointed out that the focus should remain on putting the  domestic house in order.


Analysts are sceptical on the expected path of CPI inflation, as inflation is contingent on a number of factors including monsoon rainfall, increases in minimum support prices, rural wages and government spending, none of which are perfectly predictable. Inadequate investment in the agricultural supply chain acts as a further constraint. Over the past few years, consensus expectations on Indian inflation have consistently underestimated the outturn.  Expectations of further rate hikes are modest. However, few believe that they are likely to be cut quickly. 


Following the announcement of taper in December the rupee has  been stable hovering around 62 levels . The beginning of the week of 26 January saw a slight depreciation to around 63.5 levels, on the back of contagion from other emerging markets . The rupee bounced back to 62 levels after the rate hike and has stabilised around the 62-63 range. Despite the positive impact on the rupee, we think it is unlikely that the rate hike was motivated by movements in the currency .


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