Urjit report effect: RBI focusing on 8% CPI in 12 months

The Reserve Bank of India (RBI) on Tuesday increased the repo rate, the rate at which the central bank lends to banks, by 25 basis points (0.25 percent) to 8 percent.

The move came even as 45 economists in a poll of 50 were expecting RBI governor, Raghuram Rajan, to stand pat on interest rates at this monetary policy.

Also read: Credit Policy: RBI hikes repo rate by 25 bps to 8%

This is the second time in as many months the governor surprised the market: In the December review, Rajan chose to not hike interest rates, even as the consensus was he would.

The expectation then was that since inflation was high (the prevailing rate on retail inflation was 11.24 percent), the central bank chief would be compelled to take action.

Rajan, however, then said that vegetable prices had come off sharply since the 11.24 percent reading and that he would wait to see another data point before deciding his course of action.

In line with his view, inflation did fall sharply in the December reading, falling to 9.87 percent, which led economists to the conclusion that a rate hike was essentially ruled out.

Did something change between then and now?

In his short but eventful stint till now, this is not the second time the governor has gone against the grain.

But now, more than being a contrarian or being an "unconventional" central banker, there could be a larger theme at play for the governor.

Recently, a panel headed by RBI deputy governor Dr Urjit Patel -- and which comprised bankers, experts and economists from outside the central bank -- submitted a report suggesting a radical set of reforms that proposed, among other things, the RBI start setting out clear inflation targets.

The committee also outlined the RBI should try and bring down the consumer price index to 8 percent in a year and 6 percent in two.

While the central bank is yet to officially accept the recommendations of the panel -- it would, in fact, require government approval for complete acceptance -- it is clear the RBI is now specifically focusing on bringing the CPI below 8 percent in a year.

The RBI alluded to this target in its monetary policy statement clearly: “The Dr Urjit Patel Committee has indicated a “glide path” for disinflation that sets an objective of below 8 per cent CPI inflation by January 2015 and below 6 per cent CPI inflation by January 2016,” it said, adding that the rate hike was effected because had the policy stance remained unchanged, it could have resulted in “upside risks to the 8 percent forecast” over a 12-month horizon.