13th May 2022 (7 Topics)
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Did the RBI wait too long to raise interest rates?
Should the RBI have acted on interest rates much earlier?
- Growth vs Inflation: With the disruption caused by the pandemic and the Russia-Ukraine war, central banks had to walk a tightrope walk between growth and inflation. Supply shock Central banks around the world did everything they could to support growth by lowering interest rates.
- Flawed Expectations: There were indications in the market that demand conditions would improve from the pandemic years. The Purchasing Managers’ Index has begun to show consistent expansion, both for manufacturing and services. Services have bounced back even more strongly, given demand recovery. However, rising input costs have begun to now manifest in the pricing power.
- February Action: February would have been the policy time when the RBI could have articulated its concerns on not just the headline Price Index, but more on the core inflation as the economic monitor, which reflects more of underlying demand conditions.
With little impact of repo rate action, what else should the RBI do to rein in inflation?
- Hike Cash Reserve Ratio: An interest rate hike is a necessary but not sufficient condition to rein in inflation. RBI needs to manage liquidity by raising the Cash Reserve Ratio (CRR) for banks by 50 points. There will be a sacrifice on output but it will help moderate demand.
- Sacrifice growth: In the backdrop of coal shortage and the ongoing war, fuels and food prices are going to increase further resulting in high inflation. Between inflation and growth, RBI has to sacrifice on growth because inflation is a very inequitable tax on the less privileged.
- Tweak external benchmark rates: More than 75% of the assets are loans and quite a lot of these are based on T-bills or external benchmark related rates. All these notes linked to external benchmarks were already getting re-priced. So, interest rates in the market are determined by the market forces, not by fiat.
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