Rising inflation and high fuel prices prompted the Reserve Bank of India (RBI) to increase the benchmark short term interest rates by 0.25% for the first time in over four years, indicating that all is not well with macro-economic fundamentals. The increase in repo rate by 0.25% to 6.25% on June 6 has come at an inopportune time when economic growth is showing signs of a pickup and green shoots are visible in corporate investments. The hike meant that the cost of borrowing would go up, which is not a welcome sign to kickstart the economy. Balancing growth with inflation is always a dilemma for the central bank and economists always quarrel over it as it depends on which way one looks at the glass — half full or half empty. This is evident from the fact those who want to take car loan, home loan or personal loan are unhappy as they would cost more but people, especially senior citizens, who invest in fixed deposits, have reasons to smile as they would now get better returns.
The fact that the central bank has increased repo rate, contrary to market expectations, suggests that all is not well on the inflation front. Repo rates are increased usually to arrest inflation by reducing money supply. Apparently, the analysts feel that the hike is based on fears that there is a sharper-than anticipated pickup in not just headline inflation but also core inflation. Since there is evidence of soundness of domestic growth revival, it is important to keep inflation under check. A small dose of inflation is good for multiplier effect on growth but keeping inflation at a moderate level is also necessary to sustain growth.
It is in this context, the repo rate has been hiked and going forward there is a possibility of another rate hike if crude oil price stay at current levels. This is because there is already inflationary pressure which suggests that it could seep into generalised demand through stronger domestic demand, particularly rural with good monsoon forecast this year. India’s central bank has been mostly conservative with its monetary policy so that the economy drifts towards stability, necessary for healthy development. More worrying than inflationary pressure for RBI at the present juncture is the health of commercial banks with non-performing assets breaching the Rs 10 lakh crore-mark lately. Tackling this on a war-footing for RBI and government is more critical to restore the health of the economy even as it tackles inflationary pressures.