PremiumSometimes, monetary policy can turn out to be a mere formality, as was the case last Friday. The Reserve Bank of India (RBI) hiked the repo rate, or the rate at which it lends to banks, by 50 basis points to 5.9%. One basis point is 0.01%.
This increase was widely expected as it came on the back of the US Federal Reserve raising its key short-term interest rate, the federal funds rate, by 75 basis points to 3-3.25% in September. Given that the US Fed drives the direction of global monetary policy, it doesn’t make sense for any other central bank to fight the Fed. The RBI is no exception to this.
Further, the interest rates in the Indian economy have been rising anyway.
RBI has been trying to defend the value of the rupee by selling dollars from its reserves and buying rupees. Until recently, there was a lot of money floating around in the financial system, which banks had no use for. Hence, when RBI sold dollars, it pulled out this excess liquidity. This and the increased lending by banks (as we shall see) have ensured that the excess liquidity has now more or less come to an end.
Further, the lending by banks has picked up pace. As of 9 September, the year-on-year non-food credit growth stood at 16.7%, the fastest rise since September 2013.
In comparison, as of 9 September, the year-on-year growth in deposits stood at 9.5%, implying a considerable gap between credit growth and deposit growth. This gap and the end of excess liquidity in the financial system have been pushing up interest rates. The demand for money has gone up. The supply hasn’t.
The hope is that this rise in interest rates will help rein in inflation, at least the consumer-demand-driven part of it. The RBI’s retail inflation forecast for FY23 stays unchanged at 6.7%. The upper tolerance level of inflation is 6%, according to RBI’s agreement with the government.
RBI is deemed to have failed to meet the inflation target if retail inflation stays above 6% for three consecutive quarters. As the latest monetary policy statement put it: “Inflation is likely to be above the upper tolerance level of 6% through the first three quarters of 2022-23." This means RBI is likely to fail to meet its mandate this year.
What makes the situation worse is that core inflation (after leaving out food and fuel items) remains high. In August, it was just above 6%. As the monetary policy statement put it: “Core... inflation remained sticky at heightened levels, with upside pressures across various constituent goods and services." This means that inflation is not just being driven by high food and fuel prices; and it has become systemic.
Also, with the war in Ukraine dragging on, the situation is unlikely to get easier. Further, the Fed and other rich-world central banks are trying to tackle decadal-high inflation by raising interest rates, likely leading to an economic recession or a huge slowdown across the rich world.
As Jerome Powell, chairman of the US Federal Reserve, recently said: “I think that there’s a very high likelihood that we’ll have a period… [of] much lower growth." More and more economists are predicting a recession in Europe as well.
This is definitely going to impact economic growth in India as well by dragging down growth in exports, for one. Considering these factors, RBI cut the economic growth forecast for FY23 to 7%. It had earlier projected a growth of 7.2%. Globally, the way things are now, it might just turn out that RBI is being more optimistic than it should be. The optimism could be seen in governor Shaktikanta Das’ address, which ended with the following statement: “Today, despite the gathering clouds over the global economy, the Indian economy inspires optimism and confidence."