RBI governor Raghuram Rajan hints at rate cut

With low inflation, record low crude and other commodity prices, the Reserve Bank of India (RBI) governor Raghuram Rajan has hinted at a policy rate cut.

"We will strive to give you the lowest interest rates that is consistent with our effort at bringing inflation under control," Rajan said on Monday.

The central bank governor said his remarks should not be construed as an indication of what the RBI may do at the next monetary policy meeting. He said whether the central bank cuts interest rates or not will depend on various factors, including the outcome of the monsoon rains, which can impact food prices.

He said the demand for a cut in interest rates gets louder each time new data showed inflation is lower. "It can take several months for the effect of a change to be felt. So in deciding policy today, we need to predict how inflation will look approximately a year ahead, rather than reacting to recent inflation data," he said.

"Rate cuts should not be seen as goodies that the RBI gives out stingily after much public pleading. Instead, what is important is sustained low inflation," he said.

Cautioning that cutting rates works only in the short term, Rajan said, "If there aren't enough goods and services to provide for the higher demand, then the lack of supply can cause inflation to spike sharply, forcing the central bank to raise rates again."

"The boom and bust will not be good for the economy, and average growth may be lower than if the cut had not taken place," he said. He warned that central banks shouldn't try to boost the stock market by cutting rates. "We do not have to look too far beyond our borders to see the consequences of such boosterism," Rajan said, referring to China.

The RBI needs to earn the public's trust, he said, that it will act against future inflationary threats. The public doesn't believe that inflation has fallen, and is not convinced that when it does it will stay down, the governor said.

When the public thinks inflation is high, they tend to save and not buy goods and services which dims the demand in the economy. If manufacturers believe that the cost of their raw materials could rise, they are likely to price their products at a higher rate.

Rajan said India's average inflation was more than 9% between 2006 and 2013. The perception of the common man is that inflation will remain high even though in July consumer prices rose only by 3.78%, the lowest pace of growth in eight months.