By Ruma Dubey

The market was mentally prepared for a 25 bps rate hike and a CRR hike too. Instead what it got was a status quo – no hike, no change. Naturally, the market was pleasantly surprised and the Sensex and Nifty jumped up 100 points. Yes, this was not a by-the-book action by the Governor but it is probably what he foresees - food prices will come down in the next few days. Thus giving space to this expected fall in vegetable prices, it is a pragmatic approach by RBI.

On the basis of an assessment of the current and evolving macroeconomic situation, RBI has decided to keep the policy repo rate under the liquidity adjustment facility (LAF) unchanged at 7.75% and also keep the cash reserve ratio (CRR) of scheduled banks unchanged at 4% of net demand and time liability (NDTL). Consequently, the reverse repo rate under the LAF will remain unchanged at 6.75% and the marginal standing facility (MSF) rate and the Bank Rate at 8.75%.

RBI has though warned. It has stated, “RBI will be vigilant. Even though the Reserve Bank maintains status quo today, it can help guide market expectations through a clearer description of its policy reaction function: if the expected softening of food inflation does not materialise and translate into a significant reduction in headline inflation in the next round of data releases, or if inflation excluding food and fuel does not fall, the Reserve Bank will act, including on off-policy dates if warranted, so that inflation expectations stabilise and an environment conducive to sustainable growth takes hold.” So this clearly means that if inflation does not come down, CPI for Dec is scheduled to be announced on 13^th Jan’14; maybe then, based on the data coming in, RBI might take action, not waiting for a policy date.

Coincidentally, this is exactly what the previous Governor, Subbarao did when he presented the policy on 18^th Dec 2012 – he too maintained a status quo. That time too policy decision was driven by inflation and today too, the issue remains the same. And it is good to see that both the Governors have the same thought process, both realized that it is best to wait and watch the prices, expecting to see it come down soon. The only difference then and now – last year on 18^th Dec, there were expectations of a rate cut as food inflation had come down and this year, we were expecting a rate hike as CPI is unseasonally high.

People lament that RBI is concerned only about inflation and is not paying attention to growth rates. But that is precisely what the RBI is supposed to do – its prime objective is to issue bank notes, formulate, implement and monitor monetary policy, maintain price stability and ensure that there is adequate liquidity in the system.  So it is doing its duty well; it is poor governance at the Center which is the big issue.

Months after months, the retail inflation refuses to relent – like a fevicol ka jod, it remains stuck at high levels. At the core of this is obviously food inflation. So instead of asking why RBI is not reducing rates, why isn’t anybody asking why this food inflation continues to remain high? If retail inflation is the reason why RBI’s hands are tied, then isn’t it right to find out why inflation remains stubbornly high?  

Persistent high food inflation is indeed worrisome. On one hand, we have seen pictures of cereals, grains rotting away in Govt owned godowns and on the other, we pay through our nose for basic veggies. So it is apparent that it is not simple economics of high demand not keeping up with supply which is leading to inflation. It is much deeper. The Govt needs to truly find out why food inflation refuses to come down, whether it is lack of proper distribution channels, improper pricing, supply constraints. We have been seeing these pictures of putrefying grains and cereals for years now so doesn’t that mean that the Govt is simply not addressing this distribution issue? The Govt worked super fast when it came to cash subsidy, to score a point when elections come calling but aren’t rotting grains a bigger issue? When will these distribution issues ever get resolved?

RBI has no elections to win or any politics to play which is why it is doing its job well.  The onus, like always lay on the Govt. It needs to do much more – not just public spending, speeding up approvals for projects but it needs to address the issue of rotting grains first.

So what’s the next trigger for the markets now?  The Federal Open Market Committee is meeting today and tomorrow and all eyes will wait for cues on end of easing. The US central bank could begin the inevitable reduction or tapering of its $85 billion in monthly mortgage bond and Treasuries purchases very soon. That, for emerging markets like ours is not good news but on a bigger picture, it shows that the US economy is gaining momentum which is why it does not need the artificial support of stimulus.