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The RBI has raised rates in its latest policy meet at the end of January. Since a rate hike was expected in the December policy itself – the RBI surprisingly chose to hold rates in December – the hike in January didn’t come as a big surprise itself. A bigger (and probably positive too) surprise was the adoption of the recommendations in the Urjit Patel Committee report. The chief recommendation of the committee was the targeting of CPI inflation instead of WPI Inflation as is being done presently. The committee suggested a roadmap for CPI inflation – below 8% by January 2015 and below 6% by January 2016 – which was stated in the RBI policy statement. Opinion has been divided among market experts as to whether CPI inflation targeting shall be good for the economy and financial markets or not. Conservatives have praised the policy stance stating that this shall encourage higher savings - household savings rate in India has been drifting downwards over the last 4-5 years due to high inflation, low income growth and negative real interest rates. As per them, positive real rates (interest rates minus inflation) shall lead to robust and sustainable growth in the long term whilst also supporting the currency which has seen sharp depreciation in the recent past due to high inflation and global concerns. On the other hand, there is a section of experts that have openly criticized the inflation targeting policy stating RBI’s limitations in bringing down inflation and fearing that growth may be seriously damaged in the process. They claim that high inflation is because of supply side constraints and by keeping interest rates too high, the RBI is actually hurting prospects of a resurgence in investment economy which is important to address the supply side constraints. We are firmly in the former camp of conservatives and believe that any sustained revival in investor sentiments must be preceded by a growth in savings. It is important to incentivize the savers. Negative real rates promote higher consumption and not higher savings. Ever since the last investment boom ended in 2008, growth in the Indian economy has been sustained by consumption only, with investment growth virtually coming to a standstill. However, despite all incentives in the form of negative real rates, consumption has still trended lower over the last couple of years due to high inflation and slower income growth. Time has hence come to revive investment growth. We believe stimulating higher savings is the precursor to higher investment growth. In our opinion, RBI has done the right thing by targeting CPI inflation. Though it may lead to short term pain for investors and consumers, it will set us on the path of sustainable growth in the medium to long term paving the way for robust financial and investment markets.

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