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Avoidable Interest Rate Hike

The Reserve Bank of India, which regulates the money supply and its pricing in India, has increased its interest repo rates to 6.5% in the recent meeting of its Monetary Policy Committee (MPC). The repo rate is the rate at which the RBI lends to banks and serves as a benchmark for India’s interest rates. It was the second consecutive interest rate hike of 0.25% by the RBI after a similar increase effected in June 2018. As per the RBI, the increase in interest rates is in response to the rising consumer inflation, which recorded an increase for the third successive month and touched 5%, even though it is reported to have receded to 4.50% in July 2018. The present rise in prices is not because of food items but is because of other items arising from the manufacturing and service sectors. The RBI notes an upward drift in prices, which it seeks to carefully monitor, with the six-member MPC, in a 5:1 vote reiterating its commitment to achieve headline inflation of 4% in the medium term, on a durable basis as they call it.

The RBI expects uncertainty on the inflation front, arising due to a food price rise on account of an increase in MSP, the deteriorating fiscal deficit position and the oil and commodity price rises, which it says need close monitoring. It also notes with concern the global trade wars, rising protectionism, elevated oil prices and geopolitical tensions, as a grave risk to long-term global growth, which can adversely impact investment by hampering global supply chains, which will hit productivity. The flow of investments into India too could be adversely impacted. The RBI governor also predicts the onset of global currency wars, where nations will depreciate their currency to remain competitive in global trade.

It is clear that by increasing the interest rates, the RBI has chosen battling inflation, as its priority, at the cost of national GDP growth, which has been struggling to show signs of durable growth. With loans becoming expensive due to a hike in interest rates, industry and fresh investments will suffer. No corporate wishes to borrow at high interest rates, at a time when their growth/profits are uncertain. The growth in loans will suffer across the board, which includes housing loans and vehicle loans, thus giving a setback to the respective sectors, which includes real estate and automobiles. With a rise in EMI, the household savings are bound to go down, aggravating the mismatch in liquidity that the Indian economy faces at present. The profitability and recovery of banks too will suffer, with a dip in loans, rise in FD rates and inability to pass on interest rate hikes, particularly to the high rated corporates. India’s nascent economic recovery will slip, with experts predicting a dip in our GDP growth rate to 7.2%. RBI could have adopted a wait and watch policy, particularly after its recent interest rate hike in June 2018. But as an economist commented, it focussed on backward looking price signals rather than forward looking indicators of growth. With the global oil price rise having receded at present and inflation in July had fallen, this interesting hike of RBI was avoidable.

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