Thursday, 10 Oct, 2024
By: Anshul Vipat
The decision has been taken in response to the high inflation faced by the Indian economy in the recent months in the current financial year
The Reserve Bank of India’s (RBI) monetary policy committee (MPC) on Wednesday hiked the repo rate/ lending rate by 35 basis points to 6.25 percent with immediate effect. The decision was announced by Shaktikanta Das, the governor of RBI in a press conference held on Wednesday. This is the fifth repo rate hike by the central bank. Prior to this, the RBI had raised the repo rate by 50 basis points in September, 50 basis points in August, 50 basis points twice in June and 40 basis points in May.
How RBI decides repo rate
While deciding the repo rate, the RBI considers the retail inflation or the consumer price index as one of the most important factors. The CPI for October stood at 6.77 percent, down from 7.44 percent in September, while Consumer Food Price Index (CFPI) also dropped from 8.60 percent in September to 7.41 percent in October. While the inflation rate has decreased it is still way above RBI's comfort zone. The decision has been taken in response to the high inflation faced by the Indian economy in the recent months in the current financial year. Speaking about inflation, RBI governor Shaktikanta Das said that the retail inflation remains uncomfortably high and noted that inflation is expected to remain above 6 percent in the next quarter as well. The RBI governor has observed that this decision is tend to counter the rising retail inflation and ensure macroeconomic stability.
Understanding the impact on domestic consumers
The increase in Repo rate by the RBI typically results in higher funding costs for lenders like banks. As a result of the increase, the banks will pay more for the money they borrow from the RBI. Banks pass on the cost to borrowers as a result by increasing their own loan interest rates, which raises the cost of equated monthly installments (EMIs). This will result in rise of interest rates on home loans for both new and current customers.
As the chart above indicates, the retail inflation rate has been consistently above the self-posed danger mark of the central bank. According to rules fixed by the Monetary Policy Committee of the RBI, the retail rate of inflation should not exceed 4%. Anything above 4% is a hint that inflationary pressures are building up. Besides, alarm bells must ring when retail inflation crosses 6%, which it has throughout 2022. Till April 2022, the RBI kept postponing the decision to hike interest rates to control inflation as it did not want to adversely affect economic recovery. But matters started getting out of hand the same month when the retail inflation rate zoomed to almost 7.8 percent in April. Within a few days, the RBI announced a 40 basis point rate hike, followed by three more hikes.
One reason why just hiking interest rates may not be enough to tame inflation is that a lot of it is supply driven. Take the example of pulses. For the month of July, the retail inflation for this category has been a very satisfactory 0.18 percent. But sudden shortages in August have led to prices of pulses shooting up by 15 percent and more. This has so worried the government that it has invoked the Essential Commodities Act for some varieties of pulses on August 12 to control both speculation and another spike in prices.
However, there is light at the end of the tunnel. Data clearly reveals that inflationary pressures are easing since the peak levels of April. Besides, global crude oil prices have fallen below $90 per barrel after many months and analysts expect both food and fuel driven inflation to ease in the next few months. India has indeed done well compared to most economies of the world, as highlighted by an India Tracker story on July 28, 2022. Forget countries like Sri Lanka and Pakistan that are basket cases. The inflation rate in large economies like Brazil and South Africa and even advanced economies like the US and UK is higher than in India. Of course, terrible economic hardships in other countries would be no consolation for a majority of Indians as they are concerned with their own family and household budgets. They would be hoping that the projections made by the RBI about inflation dropping 2023 onwards comes true.
