ET view: Inflation battle not yet won

Raghuram Rajan will not give up his image as an inflation warrior. He will soften his stance on interest rates during the year only if the next government delivers – or, at least promises to – and the monsoon behaves. Other than rates, often perceived by investors as the magic wand, he is willing to push structural changes that could deepen financial markets: encourage banks to borrow long instead of relying on overnight borrowing window of RBI, curb foreign hot money flow in debt market and allow offshore funds to take positions in currency futures.

Irrespective of whether the next government is a stable one or a bumbling coalition, the RBI governor will fish for clues on minimum support price and subsidies before he shifts gears on rates.

Despite inflation, the headline CPI, having fallen close to RBI’s target of 8% in Jan 2015 – thanks to drop in vegetable prices – Rajan maintains a somewhat hawkish tone. In the past two months, the central bank has been attacked ruthlessly for its inflation targeting approach and the significance it puts on CPI, but the governor boldly defends it in the policy. However, it could be misleading to draw too many conclusions from the first bi-monthly monetary policy statement for 2014-15. After 45 days, a new government will take charge, and despite all the talks on the distinction between financial markets and real economy, and the independence of the central bank, Rajan’s wait and watch style is understandable.

Having revised the growth rate to 5-6% for this year, it’s too early for Rajan (even if he feels so) to signal that he has won the battle against inflation. But it would be interesting to figure out what Team Rajan does if the worst fears about monsoon come true. Will Mint Street stick to his guns and raise interest rates as food prices rise?