By Anjan Roy
Reserve Bank of India has done a delicate pirouette in formulating its monetary policy in the context of extreme volatility and uncertain events.
All RBI did on Wednesday was to raise the key rate, called the repo rate, by half a percentage point. This rate hike follows another rise just a month ago, on May 4, of 40 bps. In fact, the two hikes together raise interest rates by nearly 1%.
The central bank has left unchanged other levers, such as the cash reserve ratio (CRR), the portion of the money that commercial banks leave with the central bank. In addition, RBI has implemented some liberalization with subsidiary banking systems, such as the cooperative banks, which should help reduce the flow of money into selected sectors of the real economy.
What is the general meaning of the manipulations of the RBI and what is the intention of the central bank. The RBI has sought to keep rising prices in check without unduly compromising the economy’s growth momentum that could trigger a rise in interest rates. Behind these moves, what were the compulsions for the Reserve Bank.
Policymakers and managers face a dilemma. Prices are currently rising faster than comfortable. Maintaining price stability is the Reserve Bank’s primary mission and by making this two-step hike in its key policy rate, the central bank of India has demonstrated its commitment to maintaining price stability.
That is important, if you remember what is happening in neighboring Sri Lanka or in Pakistan. Prices in these neighbors are rising so quickly that the price of everyday items can fluctuate by as much as 50% between morning and evening.
At the same time, the Indian economy is recovering from the worst trauma of recent times from the pandemic. Just to remind you that the Indian economy shrank by a quarter in one quarter in 2020. We are now growing again and India is seen as the fastest growing major economy. That is a tough task, given the way the global economy runs and there is uncertainty. It is therefore important to boost that growth stimulus with the right incentives.
In the context of that contraction and slowdown in the economy’s pace after the COVID-19 pandemic, the central bank had sought to support economic activity by adopting an extremely accommodative stance. Bank credit was offered on easier terms and lending standards have been diluted. The continued easy money policy pursued to counteract the ill effects of the pandemic had built up significant liquidity in the financial system.
Again from the interest that prevails on the money markets. Interest is the price for money that there is a market where banks lend and lend among themselves to bridge temporary — that is, overnight — shortfalls of money or an excess of it. This is called the overnight money market. The rate for calling money has fluctuated at the moment — June 8 — around 3%.
Since the repo rate is 4.5%, it means that the Indian financial system has liquidity. Usually, as Reserve Bank Vice Governor D Michael Patra explained in the post-policy press interview, this was on the liquidity corridor floor. In one simple word, the system is full of money. Commercial banks are parking excess liquidity amounting to Rs 5.5 lakh crore din overnight deposits with the RBI.
Against this background, RBI Governor Shaktikanta Das said he would pursue a policy of normalizing monetary policy and withdrawing from an accommodative position. This is important for overall financial stability and for controlling inflation. Too much money in the system would result in racing pressure and so these normal levels should be rough.
Remember what you are trying to do is achieve price stability with growth. The mantra of reconciling the seemingly irreconcilable. The whole exercise should arguably be anchored in the dynamism of the current state of the Indian economy. Let’s make an inventory of that.
About a week ago, the National Statistical Office (NSO) released its estimates that India’s real gross domestic product (GDP) growth in 2021-22 was 8.7%. This equates to 1.5% above pre-pandemic levels (2019-20). In the fourth quarter of 2021-22, real GDP growth slowed to 4.1% from 5.4% in the third quarter, mainly due to weak private consumption driven by the Omicron wave.
As a conservative institution that is the RBI, the central bank has projected a growth rate of 7.2% for 2022-23. This is in line with the World Bank that released its World Economic Prospect on Monday. In fact, the World Bank lowered its estimate of India’s growth from over 8% in January to 7.5% now. The downward revision is due to the increase in COVID cases and mobility restrictions in large areas.
Nevertheless, RBI Governor Das believed that the growth impulses were strong with a high utilization rate of the manufacturing sector of over 75% and a strong increase in demand in both rural and urban areas. In addition, Governor Das especially emphasized the robust export performance and the large foreign exchange reserves. Strong import trends —particularly in capital goods- also signaled a resumption of the cape cycle and more capital investment is expected in the coming months.
These certainly provide a buffer against global headwinds. The raging war in Europe is pushing up commodity prices everywhere. The oil price is well above its previous level, thus exerting strong upward pressure on aggregate prices. The average price of crude oil in India has risen to $105 a barrel, from $85 a barrel last year.
As the RBI noted, three quarters of the current price increase is due to spurts in food and fuels. Delivery interruptions occur resulting in occasional price increases for selected items. These also disrupt production processes.
There are widespread fears that the global economy will return to a recessionary cycle when the rebound has just resumed after the pandemic. India will need to maintain its growth momentum and fight the bad winds of stagflation in the global economy. Last but not least, an easy job. (IPA service)
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