Can The RBI Really Tame Inflation?

By: Sutanu Guru

After a brief respite, retail inflation is again above the 6% mark. Now, the RBI might find it tough to hike interest rates

They say: if winter comes, can spring be far behind? When it comes to retail inflation based on the Consumer Price Index, those words o hope seem to have gone for a toss. In winter 2022, particularly in the months of November and December, retail inflation dropped below the danger mark of 6% after many months. But that respite was short lived. Inflation climbed again to 6.4% in January 2023 and inched further up to 6.51% in February 2023. As per rules framed long ago, the RBI says it has cause too worry when retail inflation goes above 4% and is obliged to take steps when it crosses 6%. The only concrete step the RBI can take realistically is to raise interest rates. Significantly, the retail inflation rate has remained above 4% throughout 2022; and above 6% for most months.

Source: Reserve Bank of India

Even in 2021, the retail inflation had been above the “comfort” level of 4%, often hovering around the “alarming” 6% mark. But RBI Governor Shaktikanta Das and the Monetary Policy Committee resisted the demand of “hawks” to raise interest rates to be able to tame inflation.But they were left with no options when retail inflation skyrocketed to 7.8% in April 2022.

Beginning May 2022, the RBI has hiked interest rates fur times in 2022, raising the Repo rate 4% early in the year to 6.5% in December 2022. Governor Das has been candid enough to admit that the chances of retail inflation dropping below 4% appear very slim in the near future. He does face a Hobson’s choice as he acknowledges that high interest rates will have a deleterious impact of the GDP growth rate of the economy. As a matter of fact, there has been an impact. In January 2022, almost everybody predicted that the GDP growth rate of India in the financial year 2022-23 would be between 8.5% and 9&. In reality, the growth rate is struggling to touch 7% as the year draws to a close.

Quarterly GDP Growth Rates in 2022-23 (%)

Source: MoS&PI

No doubt, rising interest rates would not be the only factor behind the disappointing GDP growth rates. But they have played a role. Higher interest rates mean increased EMIs for households that take loans to finance consumer purchases, not to speak of those who can a ord to pay housing loan EMIs. While the afluent have not really been affected, it is the aspirational classes that suffer. Consumer sentiments have been quite weak since the Covid pandemic hit India in March 2020. In a recent report submitted by CVoter Foundation to the Economic Advisory Council to the Prime Minister, more tha two thirds oof the respondents said that they were finding it very difficult to manage household expenses and finances. This has directly affected consumer buying behaviour as reflected by available and credible data. Four wheelers are usually purchased by relatively better off Indians. Sales in 2022 broke all records and crossed 3.8 million units. Two wheelers are the domain of aspirational Indians. In 2022, two wheeler sales limped up to 17 million units, way below the 22 million recorded in 2018. A further hike in interest rates as demanded by monetary policy hawks could make matters worse. 

Source: Ministry of Finance

The pie chart above makes it crystal clear why high GDP growth rates on a sustained basis unless aspirational Indians feel confident about their future economic prospects. That is when they will open their digital wallets or take retail loans to buy two wheelers, smart phones, refrigerators, smart TVs and other products and services that will drive economic growth. FMCG and consumer durable companies have been reporting that sales in rural India are picking up after almost three years of subdued sentiments and sales. An interest rate hike could threaten to derail the revival. The choices for Shaktikanta Das are not easy. Odds are, he will be damned and slammed either way.