Rajan the dove

RAGHURAM RAJAN, the governor of Reserve Bank of India, has a reputation as a monetary-policy hawk, a central banker who frets more about stubborn inflation than sluggish growth. But he also has a fondness for surprises. Twice this year he cut the central bank’s main rate outside the usual schedule of the RBI’s bi-monthly monetary-policy meetings. Today he sprung a bigger surprise by cutting interest rates by half a percentage point, to 6.75%. Some analysts had thought Mr Rajan might even keep rates on hold. Most expected a cut to 7%. Inflation has been stable at 3.7%, well below the RBI’s near-term target of 6% and lower even than its medium-term goal of 4%. The economy has been growing at a respectable annual rate of 7%, but could still use a little stimulus. Yet no one really expected such a big cut.

What prompted it? The decision of the Federal Reserve not to raise interest rates in America earlier this month created room for the RBI to sneak in a big rate cut now. But growing concern about the world economy was the main spur. In a prepared statement, the RBI noted that global growth had weakened, particularly in other emerging-market economies, since its last monetary-policy meeting at the beginning of August. Global trade is shrinking by some measures. China’s stockmarket crash and the slight devaluation of the yuan has unnerved financial markets. Capital is flowing out of emerging markets already hurt by falling commodity prices and slow trade. India’s economy is holding up fairly well in the circumstances (it helps that it is a commodity importer with few strong ties to China). A pick-up in industries, such as clothing, furniture and cars suggests that India’s bounce-back from a rocky period in 2013 is being led largely by consumer spending. But the recovery “is still far from robust”, says the RBI. India cannot evade the global misery. A more persistent drag to growth from weak exports is now likely.

Even so there seems more to this big rate cut than just increased nerves about the world economy. The RBI has only marginally marked down its forecast for GDP growth this fiscal year, from 7.6% to 7.4%, so today’s big cut marks a significant shift in Mr Rajan’s mindset on inflation. In August he fretted that a shortfall of rain during the monsoon might push up food prices and thus inflation (half of India’s farms rely solely on rain water for irrigation and food accounts for half the consumer-price index). The monsoon has indeed proved deficient: rainfall has been 14% below its normal level. But food prices have been largely unaffected. The RBI now reckons that grain production has actually been higher than last year, thanks to pre-emptive action by government agencies. Meanwhile there has been no let-up in the downward pressure on inflation. The price of oil and other commodities is low. The RBI says a weaker global economy and overcapacity will mean cheaper imports for India.

Does that mean rates go lower? Not right away. The RBI says its immediate focus is on working with government to push state-owned banks to pass on lower borrowing costs to consumers and companies. Inflation is also set to rise in the coming months because of unfavourable base effects. Yet there the news from China and other emerging markets seems likely to worsen. Mr Rajan is probably not finished yet.