RBI’s Monetary Policy Committee (MPC) meeting held between June 6th to 8th has decided to hike the policy repo rate under the liquidity adjustment facility (LAF) by 50 basis points. The decision has resulted in an upward revision of the Repo rate from 4.40 percent to 4.90 percent, the standing deposit facility (SDF) rate stands corrected at 4.65 percent, and the marginal standing facility (MSF) rate and the Bank Rate at 5.15 percent. It was also decided that the monetary policy would continue to focus on the withdrawal of the accommodation while supporting growth. The rate hike has been widely expected in the backdrop of mounting consumer price inflation which clocked an eight-year high of 7.79 percent in April and 6.30 percent in May. Also, the central bank had to take various challenges emanating from the global front into consideration, including persisting geopolitical turbulences, volatile capital flows, high exchange rate fluctuations, and mounting commodity prices.
On the domestic front, April-May 2022 data indicate a broadening of the economic recovery. Both Urban and rural demand is gradually recovering. Merchandise exports showed consistent growth for the fifteenth month in May. Also, non-oil and non-gold imports remained robust, suggesting the healthy recovery of domestic demand. Overall, system liquidity remains in surplus. Food inflation remains a problematic factor, as considerable spikes were witnessed across various food categories such as cereals, milk, fruits, vegetables, spices, and prepared meals. Fuel inflation was majorly affected by a hike in LPG and kerosene prices. Core inflation, which indicates consumer price inflation excluding food and fuel, increased across almost all components, dominated by the transport and communication sub-group. At this outset, the RBI has retained the GDP growth at 7.2 percent and inflation at 6.7 percent for FY 2022-23.
The Reserve Bank of India is not the only central bank that has resorted to hawkish monetary policy. In 2022 alone, more than 45 central banks that include both advanced and emerging economies have substantially raised policy interest rates. Moreover, several central banks have hiked interest rates in quick succession. For instance, to mitigate the ongoing high inflationary pressure (beyond 50 percent), Argentina has increased the policy rates in Mar/April by 250 basis points and 200 basis points in May. In the case of Brazil, it was 100 basis points for each period. Poland was forced to revise the rates by 100 and 75 basis points during the same period to tackle the double-digit inflation. Not just emerging countries but countries like the United States (25 and 50 basis points hike) and the UK (25 and 25 basis points hike) were also considerably affected by high and persisting inflation.
Containing inflation and inflation expectations is crucial as mounting prices can cause economic and political havoc. However, the monetary tightening on a global scale is happening at a time when the global economic recovery should have been of utmost importance and maximum support. In the case of India, the current hike of 50 basis points would result in approximately Rs 15,410 crore interest cost on Retail & MSME consumers. The business sector -especially the MSME sector- which is slowly recovering from the miseries of the Covid-19 pandemic, will find it challenging to cope with the rising interest payment and costly credit.
A Keynesian would probably argue that unless aggregate demand is restored, the path of economic recovery would not be quite easy for an economy. This argument is valid in the Indian context as the country’s GDP growth has been slowing down even before the advent Covid-19 pandemic, primarily due to problems stemming from the demand side. Studies indicate that in countries like India, a hike in real interest rate will mostly have a positive impact on savings rather than consumption. Rising savings and falling consumption levels are obviously not the panaceas that the economy needs right now. Of course, higher savings in the economy will undoubtedly help the fiscal authority pool a large volume of funds from the market by issuing debt instruments. Further, the government is expected to follow the simple Keynesian policies to inject more money into the hands of the people. However, the real key to sustainable economic recovery lies in monetary-fiscal policy coordination.
An economic analysis conducted by SBI indicates a negative but statistically insignificant correlation between the fiscal and monetary policy in the Indian context, implying a lack of fiscal and monetary coordination. As far as monetary policy is concerned, the Reserve Bank of India has been effectively communicating its intentions and managing the difficult task of containing inflation while upholding the growth aspects. Now, the ball is in the government’s court to supplement the monetary policy response with suitable fiscal measures.
(The writer is an assistant professor at Sarla Anil Modi School Of Economics, NMIMS. He was previously associated with Christ University Bengaluru, Central University of Rajasthan, and IIM Bangalore.)
