- What was largely anticipated but fervently hoped to keep the matter away as long as possible is finally upon us. As the phenomenon kept playing out in every country across the globe, the inflation plaguing the nations on the back of extraordinarily turbulent two-plus years since the pandemic is finally coming out in the open much to the discomfiture of the common citizens. Add to it the ongoing Russia-Ukraine war leading to cascading effects on essential commodities including the all-important energy scenario, and the recipe for even more distressful days ahead is apparent. The fiscal policymakers had to act, and many nations are already witnessing the same.
PC: DR SIDDHARTHA SAHU
- In the Indian context, the Reserve Bank of India too took the much-dreaded action when its monetary policy committee surprised the market recently. Mind you, a little over three weeks after the six-member MPC voted unanimously to hold the policy repo rate at 4%, they changed course and increased it to 4.4% in an off-cycle meeting. Yes, it’s the first increase in repo rate since August 2018. RBI will separately increase the cash reserve ratio maintained by banks by half a percentage point to 4.5%. This is expected to suck out an astonishing Rs. 87,000 crores of liquidity. Monetary tightening is well and truly underway from now on.
- However, MPC was largely expected to nudge up interest rates later this year. As such, the moot point to ponder over here is what triggered an unscheduled meeting to advance this. The answer is a combination of elevated inflation and the uncertainty around inflation’s trajectory. As mentioned above, a volatile geopolitical situation has fuelled a surge in the prices of many commodities. The pain has already shown up in India – retail inflation in March was 6.95%, led mainly by a jump in food prices. Unfortunately, this surge in inflation has come at a time when even if aggregate demand is back at pre-pandemic levels, it’s not yet robust though.
PC: MONEYCONTROL NEWS
- Nonetheless, the abrupt turn in monetary policy was catalyzed by further apprehension. Note that the surge in fuel and food prices has come at a time when the price level of other items of consumption, read as core inflation, has remained high at around 6% for a year. Thus, MPC appears to fear the potential second-round impact of high commodity and food prices which occurs when firms raise sales prices and employees seek higher salaries to adjust to changing circumstances. Therefore, the primary aim of an increase in repo rate at this juncture is to head off the second-round effects and preserve macro-financial stability.
- Consequently, the changes will work their way through the economy’s full spectrum of interest rates leading to a rise in borrowing costs on personal and home loans. For savers in fixed income instruments, rates are set to increase. Indeed, the key takeaway from the announcement is the return of inflation as an important macroeconomic challenge forcing the RBI to prioritise fighting inflation over stimulating economic growth. Yes, it does shift the onus onto both the Union and State Governments to adjust fiscal policy to adapt to the emerging situation. Imperatively, taxes on pump prices of fuel need to be lowered now to ease price pressure. Hopefully, the right fiscal policy will insulate the economy from a demand shock at this critical juncture.