The Reserve Bank of India decided to keep the benchmark interest rates of the economy unchanged during bimonthly review of monetary policy -Why?

 

India’s central bank, the Reserve Bank of India, decided to keep the benchmark interest rates of the economy unchanged. The decision was taken after three days of deliberations by the Monetary Policy Committee of the RBI.

Going into the bimonthly review of monetary policy on August 4, there were varying expectations from the RBI. There were people who expected the RBI to cut the repo rate — the interest rate that the RBI charges when the banking system borrows from it — given the increasingly worsening forecast about India’s economic growth.

Why did the RBI not cut rates?

• Given that the Indian economy is still grappling with fresh localised lockdowns to control the Covid-19 spread, and the continuing concerns over demand, especially in sectors such as residential real estate and consumer durables, there was increased expectation that the RBI will further cut policy rates by another 25 basis points (one basis point is one-hundredth of a percentage point) to stoke growth.
  There could be two main reasons why the MPC did not cut rates.
• One, retail inflation, measured by the Consumer Price Index, rose in June to 6.09 per cent from 5.84 per cent in March, breaching the central bank’s medium-term target range of 2-6 per cent. That seems to have been a major red flag, which prompted the MPC’s unanimous decision to refrain from cutting policy rates.
• Das specifically flagged concerns over domestic food inflation remaining elevated, even as he mentioned that agriculture sector prospects have improved with the good monsoon and the rise in the kharif sowing area.
• Two, in May, the MPC had cut the repo rate by 40 bps to 4 per cent, while maintaining its accommodative policy stance. In effect, during the course of the last seven months, the MPC has already slashed the repo rate by 115 bps amid the COVID-19 outbreak and consequent economic fallout, even as transmission by banks to customers is still to kick in fully.
• On the broad outlook, Das said the global economic activity remains fragile, even as the financial markets have been buoyant. Real GDP growth will remain in the negative, he said, even as “any positive news on the COVID-19 containment efforts would change this scenario”.

What is the link between growth, inflation and interest rates?

• In a fast-growing economy, incomes go up quickly and more and more people have the money to buy the existing bunch of goods. As more and more money chases the existing set of goods, prices of such goods rise. In other words, inflation (which is nothing but the rate of increase in prices) spikes.
• To contain inflation, a country’s central bank typically nudges up the interest rates in the economy. By doing so, it incentivises people to spend less and save more because saving becomes more profitable as interest rates go up. As more and more people choose to save, money is sucked out of the market and inflation rate moderates

What happens when growth rate decelerates or contracts?

• When growth contracts, as is happening in the current financial year, or when its growth rate decelerates, as was happening right through 2019, then typically, people’s incomes also get hit. As a result, less and less money is chasing the same quantity of goods. This results in either the inflation rate decelerating (that is, prices grow at 1% instead of 5%; also called “disinflation”) or it actually contracts (also called “deflation”; that is, prices reduce by 1% instead of growing at 5%).
  In such situations, a central bank nudges down the interest rates so as to incentivise spending and by that route boost economic activity in the economy. Lower interest rates imply that it is less profitable to keep one’s money in the bank or any similar saving instrument. As a result, more and more money comes into the market, thus boosting growth and inflation.

Why has RBI not raised interest rates when retail inflation has been above the comfort zone of 2 to 6% for most of the year?

• RBI is facing an odd situation at present: GDP is contracting even as inflation is rising. This is happening because the pandemic has reduced demand, on the one hand, and disrupted supply on the other. As a result, both things are happening — falling growth and rising inflation.
  It is true that for containing inflation, RBI should raise interest rates. And under normal circumstances, it would have done just that. But raising interest rates at this stage would be catastrophic for India’s GDP growth.
• However, RBI could not have cut the interest rates as well because the inflation rate has been above the 6% mark for all the months in 2020 barring March. If the RBI cuts the interest rate, it may be fuelling retail inflation further. It must be remembered that inflation hits the poor the hardest.
• So, the RBI has chosen to do what many expected it to do: stay put and wait for another couple of months to figure out how growth and inflation are shaping up.

Courtesy : IE

👉Click the link below to see the details about the UPSC –Civils courses offered by Triumph IAS. https://triumphias.com/pages-all-courses.php

👉For Course Inquiry call Rakhi Bisht #7840888102 

👉Connect to Vikash Ranjan Sir #8586861046

👉For more such notes, Articles, News & Views Join our Telegram Channel. https://t.me/triumphias