Friday, October 02, 2015

Surprise decision by RBI Governor

Raghuram Rajan has taken everyone by surprise, pleasant or unpleasant depending on the lobby concerned, by reducing the Repo rate by 50 basis points to 6.75% The government and the borrowers are happy. Savers of money who provide the raw material for capital formation are shocked.

Why did the Governor do the unexpected? It is of course possible that he was truly convinced that the risk of inflation is now less than the risk of absence of growth. It is also possible that political pressure has breached the tipping point.

Perhaps psychological factors were also at play. Some of us, at least sometimes, come under the grip of 'Surprise Bias'. The Governor may have yielded to the urge to create a surprise. Secondly, central bank chiefs do not like their actions to be predictable. Therefore, Rajan might have swerved from his earlier consistent path of fighting inflation.

Inflation risks have not subsided. RBI's objective is to achieve 4% (plus or minus 2%) consumer price inflation rate. The economy is now within this range. However, low commodity prices (particularly oil) may not last. Impact of unfavourable SW monsoon is yet to be assessed. Raghuram Rajan has taken an uncharacteristic risk.

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