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Predictively, the hike in interest rate will not come down
Photo Credit : Twitter/ Shaktikanta Das
Central banks globally are in a panic mode, with each one of them frantically increasing their interest rates. In a scenario where leading economists of the world bank are warning about recession by 2023, it is no surprise everyone is trying to control inflation rates.
In a nutshell, this means, the lending rate to the common man will increase, and they will have to pay a heavier interest rate to the bank. This means lending and borrowing will go down, leading to a decrease in manufacturing and local business growth. This situation adds up to a lower rate of growth in a country’s GDP.
Despite this, the Reserve Bank of India (RBI) raised the repo rate to 5.9 percent, a 50 basis points increase or a 0.5 percent increase from before. During the pandemic scenario, the repo rate was around 4 percent. It is now at 5.9 percent. Last week, Federal Reserve, RBI'S American contemporary increased the federal rate by 75 bps. Keeping up with the trend of removing money from the market to control inflation, RBI has come up with this move. The last time we were at about a 6 percent repo rate was early 2019, just before the lockdown. Not only this, but the RBI itself has projected the growth rate to slow down from 7.2 to 7 percent.
Why is it a good thing?
This move by the central bank was not unprecedented and was an easy-to-make prediction in an otherwise volatile economic situation. On the face of it, a higher repo rate is an impediment to manufacturing and overall GDP growth. However, there is more than what meets the eye. “World has witnessed two major shocks in last 2.5 years,” said RBI governor in a statement associated with the release. These are Covid and the Russia- Ukraine war. The third is the aggressive monetary policy of many countries.
A close look at the Indian market indicates that private consumption has been holding up, rural demand is increasing, investment demand is picking up, and the agriculture sector remains resilient. Additionally, cereal price pressures spread from wheat to rice. Russia and Ukraine used to export wheat in bulk prior to the war, which has halted. This has led to an increase in the price of wheat. India has also implemented a 20 percent duty on rice, pushing up the price of rice as well.
Also, delayed withdrawal of monsoons has started to impact vegetable prices, which is adding to inflation. The Consumer Price Index (CPI) which we use to measure inflation for consumer goods, is thus expected to remain high at 6.7 percent and not come down. Predictively, the hike in interest rate will not come down. Das also added that Indian Rupee has depreciated only 7.4 percent only as against many other countries that are worse off. The rupee has depreciated only 4 percent, which is strong given that the Dollar has appreciated 14 percent. The Forex ‘umbrella' remains strong, Das further added. Also, FDI improved to $18.9 Bn from April to July. The service sector will offset any fiscal deficit. Given these facts, the RBI is sure they can meet external financing requirements with ease. A rise in repo rate won't have as much of a negative cascading impact.
From the economics angle, RBI is trying to dry out the liquidity from the market. This will help control inflation. For this, the RBI has decided to merge the 28-day Variable Rate Reverse Repo (VRRR), with the 14-day VRRR. This means they will now have 14-day VRRRs. This will help "injection as well as absorption of liquidity" as the governor puts it. With an ever-rising deficit, this is usually a smart move. In a nutshell, the RBI is confident about the Indian economy, be it external or internal shocks. The festive and wedding season is around the corner, and consumption inevitably increases at this time. The low amount of liquid cash might not have as large an impact as it would otherwise. However, like any policy, only time will tell about the prudency of the move.