Rajan walks the talk on inflation, surprises with repo hike

Reserve Bank governor Raghuram Rajan lived up to his credo of "never say never" by announcing an unexpected hike in benchmark repo rate. Only last week, 45 of 50 economists polled by Reuters expected the repo rate to be kept unchanged.

Dr Rajan said the decision to hike interest rates was a close one, but the central bank's decision to act was aimed at persistently high and sticky inflation. Consumer price inflation (CPI) eased to a three-month low of 9.87 per cent in December but remains well above the central bank's comfort levels.

Stating that the RBI will continue to target inflation, Dr Rajan said, "Let's fight the fight that needs to be fought."

Last week, a central bank panel headed by Urjit Patel proposed revamping of monetary policy structure by setting a CPI inflation target of 4 per cent, plus or minus 2 per cent, over the long term, with a goal of trimming CPI to 8 per cent by January 2015 and 6 per cent by January 2016.

Dr Rajan said the recommendations of the panel were being studied and the central bank will enter into a dialogue with the government, when it decides to proceed with these recommendations.

For now, the RBI said that consumer inflation risks remain to the upside.

"An increase in the policy rate ... will set the economy securely on the recommended disinflationary path," the central bank said in a brief policy statement.

The surprise rate hike pressured banking stocks and the widely tracked Bank Nifty fell as much as 2 per cent after the announcement. Bond prices fell and the rupee also pared its losses.

Analysts, however, said the RBI's outlook was dovish, which led to a recovery across asset classes. R. Sivakumar, head of fixed income for Axis Mutual Fund said markets saw a silver lining in the central bank's outlook.

"What is far more encouraging from the market's perspective is that the RBI has signaled they are probably done with rate hikes, and if inflation moderates more than what they have indicated, they may become more accommodative," Sivakumar said.

"That is basically central bank speak for they may start delivering rate cuts going forward."

Dr Rajan, however, said the primary focus of RBI is not the investor, not markets but common consumers.

RBI cognizant of weak macro economy:

Tuesday's rate hike, the third since Dr Rajan took charge of the RBI in September, will create more challenges for India's struggling economy that is growing at the slowest pace in a decade.

According to the central bank, the Indian economic growth is likely to fall short of its earlier projection of 5 per cent this fiscal year.

Dr Rajan, however, said he was not giving up on growth for the next few quarters.

"I am confident that inflation will be brought within tolerable limits, which will give room on the monetary front," he said.

He said the central bank's focus on getting macro-stability in India has started bearing results and the rest, including growth, will follow.