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Tightrope walk

  • Published
    9th Oct, 2023

Context:

Reserve Bank is facing a dilemma as rising inflation threatens stability, but concerns over economic growth and external vulnerabilities complicate interest rate decisions.

RBI's Dilemma

  • Inflation Warning vs. Unchanged Rates: The RBI's Monetary Policy Committee (MPC) left interest rates unchanged despite warning of high inflation risks, indicating a tough spot
  • Inflation Acceleration: Inflation surged in Q2, surpassing RBI's projections, and MPC raised Q2 inflation projection, suggesting potential underestimation.
  • Temporary Respite Hopes: MPC hopes for short-term relief from lower LPG and vegetable prices, with a readiness to use Open Market Operations if needed.

Balancing Growth and Inflation

  • Unwillingness to Raise Rates: RBI's reluctance to increase rates shows concerns about fragile economic growth despite inflation threats.
  • Doubts over GDP Growth: Doubts about the accuracy of GDP growth estimates and cautious forecasts indicate economic uncertainty.
  • External Risks: Weak goods exports, erratic monsoon, and a weakening rupee pose risks to the RBI's 6.5% GDP growth projection for FY24.

Risk of Imported Inflation

  • Weakening Rupee: The rupee's 0.7% depreciation since August increases the risk of importing inflation and external vulnerabilities.
  • Question of Rate Hike: RBI must consider raising rates to address these risks and maintain economic stability.
  • External Sector Vulnerabilities: Failing to raise rates could exacerbate inflation and external sector vulnerabilities, warranting a cautious approach.
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