Despite rising inflation, RBI holds interest rates at lowest-ever

Bubble in the making as RBI takes eye off the inflation ball

Business

April 9, 2022

/ By / New Delhi

Despite rising inflation, RBI holds interest rates at lowest-ever

RBI holds lowest interest rate ever with repo and reverse repo rates at 4 pc and 3.5 pc (Photo: Reuters)

By keeping interest rates at record low levels, despite mounting inflation that has gripped the entire economy, the Reserve Bank of India is taking a huge leap in the dark and with it a big risk of putting the Indian economy on a slippery slope from which recovery will be difficult.

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The Monetary Policy Committee of the Reserve Bank of India that ended its two-day meeting on Friday has decided to keep the repo and reverse repo rates at 4 pc and 3.5 pc respectively, the lowest-ever levels for both the benchmark rates.

The decision was taken even as the MPC and the RBI are staring at spiralling inflation that could get out of the hand at any given moment.

The markets had anticipated that the RBI would take the decision to hold the rates even with the monster of inflation breathing down its neck and hence the stock markets have brushed it aside. However, the stance taken by the Central Bank is highly worrying as inflation has long been above the range set by the bank and is only set to rise further with the prices of crude oil as well as commodities racing to new highs.

Already, the bank’s role as the guardian of the national economy and the inflation has come under a cloud following revelation that the RBI colluded with the federal government in order to let inflation go higher than its target in order to keep the interest rates low. This highly debatable move was done at the behest of the finance ministry and the government as it is keen to ensure that the Indian economy, that had long been in a downward spiral, ever since the bizarre and ridiculous move by Prime Minister Narendra Modi to go in for demonetisation in 2016.

The economy that was struggling ever since had its back broken by another suicidal decision to impose one of the harshest lockdowns that resulted in Indian GDP collapsing by almost 25 pc in the first quarter of fiscal year 2021. India ended the year with its GDP lower by 7.3 pc, making it the worst-hit large economy in the world.

While a semblance of growth has returned to the market, Indian economy continues to underperform comparable economies in the world, mainly due to the flawed policies of the finance ministry which refused to cater to the demand side of the economy, keeping its actions focused on the supply side, mainly by cutting corporate taxes as well as making credit available to some companies.

Despite suggestions by leading economists to inject cash in peoples’ pockets in order to help them buy essentials and hence create demand in the economy, the government has so far refused to pay heed to these calls. Its sole assistance to the people has been 5 kg free grains per month, pretending that it was sufficient to push the economy back on track, even in the face of data from all and sundry that over 130 million Indians had been pushed into extreme poverty and warnings by the United Nations that the efforts of 10 years of lifting close to 230 million people out of extreme poverty had been undone.

Institutions like British charity Oxfam, which tracks inequality, have flagged that India saw the sharpest rise in inequality during the pandemic as scores of millions had trouble even feeding themselves twice, leading to a huge jump in malnourishment and stunted children as well as anaemia amongst women, areas where India already had the dubious privilege of being a world leader, faring even worse than sub-Saharan Africa.

Playing with fire

Though the RBI has a target of keeping inflation within 4 pc, with a tolerance of 2 pc more, the inflation had been hovering close to the 6 pc mark for many months and this year, in January and in February, they breached the target and inflation rate was reported at 6.01 and 6.07 pc respectively. With the commodity prices, notably crude as well as grain and fertiliser prices scaling unprecedented heights since the Russian invasion of Ukraine, the consumer prices continued to rise right through March as well. The pace of acceleration in inflation rate is certain to have picked up sharply in the past two weeks as fuel prices have risen by well over 15 pc and this is bound to have an impact on inflation.

After months of living in denial, the RBI finally acknowledged the risk of inflation in its MPC meeting on Friday and it has revised its inflation forecast to 5.7 pc for the ongoing fiscal, up from 4.5 pc in that was announced in February. The RBI says that it expects 6.3 pc inflation in Q1, 5 pc in Q2, 5.4 pc in Q3 and 5.1 pc in Q4.

Though the RBI Governor Shaktikanta Das may have been forced to recognise the threat of inflation, he has again bowed to the wishes of the government by underestimating the inflation for the year. With inflation in the first two months of the calendar year already above 6 pc, and the following months certainly to be much higher, it is a wonder how Das expects the inflation for the entire fiscal to be at 5.7 pc, given that April itself would be nothing short of 6.5 pc and the impact of fuel price and commodities price rises yet to be factored in fully.

Globally, many central banks have been raising rates or warning of several rate rises coming in the current year. The US Federal Bank raised its benchmark rate by 25 basis points to a range of 0.25 pc -0.5 pc last month, the first interest rate hike since 2018, while in London, the Bank of England raised its rates in March for third time consecutively, taking the benchmark rate to 0.75 pc. Both the banks have acted to tamper down the inflation and similar examples can be found in most parts of the world, bar a jarring exception or two.

In many ways, the story being played out in India is very similar to the one that has been unfolding in faraway Turkey where President Recep Erdogan has rejected all talk of inflation and forced his central bank governor to keep the interest rates so low that the markets no longer believe the central bank or the government for most of its data. With inflation riding at 55 pc, the Turkish Lira has already fallen by over 50 pc in value against the USD.

Though the INR has depreciated by about 3 pc since January 2022, it is still holding fort as the market players, especially the foreign institutions, adopt a wait and watch approach towards what Das would do next. If he follows the dubious example of his Turkish counterpart and continues to live in denial over inflation or indeed continues to follow the diktats of his political masters, sacrificing even the little remaining perception of Constitutionally-guaranteed independence of the RBI, a similar bloodbath, like the one seen in the financial markets of Istanbul, may well be seen in the Dalal Street sooner than later.

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