The U.S. Federal Reserve’s
decision last week to leave interest rates unchangedoffers an amber signal for Reserve Bank of India Governor Raghuram Rajan as he prepares to make the fourth bi-monthly monetary policy statement for the fiscal year on September 29. The Fed’s move in delaying the much-anticipated start of ‘normalisation’ of interest rates provides some elbow room to Mr. Rajan as it removes, for now, the risk of rate arbitrage seeking capital outflows. The reasons cited by Fed Chair Janet Yellen for the decision to postpone the initial increase were mainly heightened uncertainties in the global economy including in China and the emerging markets, and a slightly softer expected path for inflation in the U.S. While Mr. Rajan’s decision will predominantly flow from the RBI’s reading of domestic conditions — including food price trends, banks’ lending rates and how far they reflect earlier interest rate reductions, removal of supply-side bottlenecks and assessments of the targeting of public spending and credit flows — one factor predicating the retention of the RBI’s accommodative stance as spelt out in August was the sign from the U.S. To that extent, the Fed decision opens a window of opportunity for the Indian central bank to further lower domestic borrowing costs if in its reckoning the balance between spurring growth momentum and taming inflation expectations has tilted favourably away from price gains. The latest data from the government on wholesale and consumer prices
indicate an appreciable slowing of inflation, while the Nikkei India Manufacturing Purchasing Managers’ Index for August shows a softening in both output growth and new orders from the preceding month.
That Mr. Rajan himself and Deputy Governor Urjit Patel, speaking separately and in different contexts but on successive days, have both underlined that the central bank believes
inflation expectations need to be anchored from a longer-term perspective rather than reading much into the latest data points, makes one less sanguine that the RBI may be ready to switch the green light for further policy accommodation. And Mr. Rajan’s caveat that the pursuit of growth must be tempered by the lessons offered by developments in Brazil, and that too much stimulus risks fanning inflation and deficits along with faster growth, is another straw in the wind. With a drought-like situation looming and the prospect of renewed pressure on prices from farm products and a waning base effect further clouding the picture, the prospect of the central bank opting to wait and watch till its December 1 meeting is real. And the Fed will inevitably have to bite the bullet and initiate its lift-off: it is only a matter of timing. This gives scope for Mr. Rajan to see the amber as a cautionary pause.
