RBI raised repo rate by 25 bps to 8%, against broad market expectations in its Third Quarter Review (TQR) of monetary policy. The reverse repo and MSF now automatically adjust according to the corridor. Midnightbreakfast was expecting it, wanting it, in line with our earlier stance of ‘no mercy’ on inflation. Had talked about it even in the last review of monetary policy.
RBI has devoted an almost a big paragraph regarding the ill – effects of persistent high inflation calling it ‘biggest threat to currency’, which ‘erodes the purchasing power’ of people, ‘an inequitable tax’ which hits the poor the hardest in its monetary policy review.
It further talked about how the ‘growth – inflation’ tradeoff, often raised in popular media is a ‘false tradeoff’ since inflation should always take first priority at the cost of growth even.
Since inflation eats into people’s income, savings and investments it resultantly affects growth. It talked about how the policy action was consistent with the guidance, which it was since core CPI and WPI both inched by in the last reading which was against the backdrop of a fall in the headline rates.
Guv Rajan seems to be in the habit of surprising the markets, which is good, in the sense that monetary policy is most effective when there is an element of surprise in it. This is where Guv Subba’s action seems to have found wanting. However, it would be unfair to blame him completely for the current state of affairs since the government was busy splurging and running huge budget deficits to fund the social welfare programs. He was trying to do what Guv Rajan is doing, i.e tightening to choke off inflationary forces.
Yields hardened even though the Guv had guided the action based on the explicit condition of hardening of “core inflation” which is what had happened. This shows that markets were as usual trying to run ahead of the reserve bank and started to take it for granted.
Midnightbreakfast, although supports the RBI action, believes there was no need to guide for accomodative monetary policy stance because it kind of dilutes the current action. Markets should be kept guessing of its next actions and it is only then it would price assets properly, i.e. higher yields.