The RBI raised the policy repo rate by 50 basis points taking the cumulative increase to a steep 90 basis points in two consecutive months. The ballooning inflation, mostly fueled by global factors, has prompted central banks world over to start tightening the money supply.
The imported nature of the current bout of inflation along with the fact that the RBI governor Shaktikanta Das himself acknowledging that 75% of the increase in the latest inflation forecast is due to food merits the question — will the interest rate hike slam the brakes on rising inflation as it is mostly driven by food and fuel?
“In India in particular, everybody knows that if you raise interest rates, it cools inflation by slowing down the economy and saying demand is going down but if the particular inflationary shock has been caused by things like food and fuel, those are not highly sensitive to interest rates. Economic growth may be a little more sensitive than food and fuel.”
Aiyar said that the aim of raising interest rates is to slow down the economy and it would be naïve to think that growth won’t be affected.
Abroad in America and Europe, there is the possibility that it will and it may be a mild recession, but everybody is aiming at slowing the economy and in India too, the economy will slow down. The aim is not to say growth will not be affected at all. Please let us not be naïve or stupid.
Terming the interest rate hikes as only a step in a long journey, Aiyar said that India is only following what other central banks are doing and not something that is unique to us and will help solve our problems.
“We are not doing something on our own, we are not doing something which we think will solve the issue as distinct from anybody else. We are saying everybody else is taking a step, a step, another step. They are taking a step and we too have to be in step with the rest of the world because if we are seen as being out of step, then people will say this guy does not understand what is happening and money can flow out of India in a big way.”
He said that moves like the recent tax cuts by the government have a more immediate impact on cooling of prices of food and fuel.
“There are different arrows in the government’s quiver for solving inflation like changes in duty structure or changes in the import export policy,” Aiyar said.
He added that the RBI raising interest rates will not help solve the problem of food and fuel.
“RBI raising interest rates is an attempt of a much larger economy overall to try and cool down demand. These two (interest rate hike and duty cuts) should not be confused and the Reserve Bank is not going to solve the problem of food and fuel.”
The RBI Monetary Policy Committee lifted the policy repo rate by 50 basis points to 4.9 percent on Wednesday, and raised the inflation forecast for the current fiscal year to 6.7 percent from 5.7 percent previously. The central bank, on the other hand, has kept its GDP growth forecast for the current fiscal year at 7.2 percent.
This article was originally published in Economic Times on June 9, 2022.