What else can the Reserve Bank do?

The Reserve Bank of India, RBI, raised interest rate by 25 basis points yesterday in its effort to keep retail inflation at 4%, as mandated by the government. The government set a target of 4%, plus/minus 2%, in 2016. Retail inflation went up to 5% in June, wholesale prices were higher by 5.77% in June, while core inflation, which takes out volatile food and fuel, rose by a four-year high of 6.5%. "We have been away from the 4% (CPI) target for several months now. And we took steps. One in June and one in August to maximize our chances that we don't drift away from 4% and we move towards 4% on a durable basis," said Governor of RBI Urjit Patel. L Venkatesh did not find anything wrong with the rate hike but she is puzzled by its neutral stance on policy. She probably feels that if the RBI expects inflation to stay high it should move to a tightening stance. The real effective exchange rate, REER, for the rupee is still overvalued by over 15%. Politicians like a strong rupee to keep inflation down by making imports cheaper but that will worsen the current account deficit. The Monetary Policy Committee, MPC, pointed to the high minimum support price of the government, which will raise prices of food, and the closing output gap, which could raise prices of manufactured products, and high inflation expectations of Indian households as reasons for the hike in interest rate, wrote A Nayar.  A survey by the RBI before the MPC meeting in June showed that Indian households expect inflation to rise by 90 basis points in 3 months and by 140 basis points to 9.9% in one year. "Logically, two successive rate hikes indicate the beginning of a rate-hiking cycle even though there is no certainty on when RBI will go for its next rate hikes," wrote T Bandopadhyay. "RBI sees too many risks and uncertainties all around." "This is possibly why RBI has frontloaded the rate hike. Also, keeping all these in mind, it has raised the retail inflation marginally from 4.7% to 4.8% in the second half of current fiscal year and 5% in the first of next fiscal year, 2020, with risks 'evenly balanced'". The rate hike was expected, given the economic figures we have at the moment, but the battle against inflation is not over yet, partly due to oil prices and partly due to government policies, wrote I Pan. "Monetary policy decisions have become fiendishly difficult," wrote D Joshi. Economists do not fully understand the effect of monetary policy on inflation and job creation, wrote Prof T Cowen. RBI stayed neutral because it cannot predict what governments will do. Best to concentrate on hard figures and keep to its mandate.