By Anjan Roy

Reserve Bank of India has done a delicate pirouette in formulating its monetary policy in the context of extreme volatility and uncertain turn of events.

All that RBI has done on Wednesday is to raise the policy interest rate —called the repo rate— by half a percentage point.  This rate hike comes on the back on another hike just a month back on May 4 by 40 bps. In effect, the two hikes together raises interest rate by close to 1%.

The central bank has left other levers like the cash reserve ratio (CRR), which is the portion of money commercial banks leave with the central bank, unchanged. Additionally, RBI has done some liberalisation with subsidiary banking systems, like the co-operative banks, which should help grater flow of funds into select sectors of the real economy.

What is the overall import of the manipulations of the RBI had done and  what is the Intent of the central bank. The RBI has sought to rein in rising prices, without harming too much the growth momentum of the economy that a rise in interest rates could inflict. Behind these moves, what were the compulsions before the Reserve Bank.

Policy formulators and managers are facing a dilemma. Prices are rising currently at a faster than comfortable pace. Maintaining price stability is the first charge of the Reserve Bank and doing this two-sage hike in basic policy rate, India’s central bank has demonstrated its commitment to maintain price stability.

That is important, if you remember what is happening in neighbouring Sri Lanka or in Pakistan. Prices in these neighbours are rising so fast that price of items of daily uses could fluctuate by even 50% between morning and evening.

At the same time the Indian economy is recovering from its worst trauma recent times for the pandemic. Just to remind only 2020 the Indian economy had contracted by a quarter in a single quarter. We are now again growing and India is billed as the fastest growing major economy. That’s a hard task, given the way the global economy is turning and there is uncertainty. So it is important to egg on that growth stimulus with proper incentives.

In the context of that contraction and drop in the economy’s pace following COVID-19 pandemic, the central bank had sought to give support to economic activity by pursuing extraordinarily accommodative stance. Bank credit was offered at easier terms and loans norms have been diluted. The continued easy money policy pursued to counter the ill effects of the pandemic had built up large liquidity in the financial system.

Again from interest rate prevailing in the money markets. Interest is the price for money that there is a market where banks lend and borrow from among themselves to tide over temporary —that is, overnight— shortages of money or excess of it. This is called the overnight call money market. The call money rate currently —June 8— hovered around 3%.

Since the repo rate is at 4.5%, it means that the Indian financial system is having excess liquidity. Ordinarily, as deputy governor, D Michael Patra of Reserve Bank explained in the post-policy press interaction, this was at the floor of the liquidity corridor. In one simple word, the system is flush with funds. Commercial banks are parking excess liquidity to the tune of Rs 5.5 lakh crore din overnight deposits with the RBI.

It is against this background that the RBI governor, Shaktikanta Das, said that he would pursue a policy of normalisation of monetary policy and withdrawal of accommodative position. This is important for overall financial stability as well as for inflation control. Too much money in the system would result in race pressure and hence these should be rough down normal levels.

Remember what you are trying to do is to achieve price stability with growth. The mantra of reconciling the apparently irreconcilable. The entire exercise would have to be arguably be anchored on the dynamics of the current state of the Indian economy. Let us take a stock of that.

Just about a week back, the National Statistical Office (NSO) released its estimates which indicated India’s real gross domestic product (GDP) growth in 2021-22 was 8.7%. This works out to 1.5% above the pre-pandemic level (2019-20). In Q4:2021-22, real GDP growth decelerated to 4.1% from 5.4% in Q3, dragged down mainly by weakness in private consumption on the back of the Omicron wave.

Being the conservative institution the RBI is, the central bank has assumed a growth rate of 7.2% for 2022-23. This is in line with the World Bank which had released its World Economic Prospect on Monday. In fact, the World Bank lowered its estimate of India’s growth from over 8% in January to 7.5% now. The downward revision has been due to the surge in COVID cases and mobility restrictions in major areas.

Nonetheless, the RBI governor Das felt that the growth impulses were strong with high capacity utilisation of the manufacturing sector at over 75% and strong upsurge in demand in both rural and urban areas. Besides, governor Das particularly emphasised the robust export performance and large foreign exchange reserves. The strong trends in imports —particularly of capital goods- also indicated a resumption of the cape cycle and more capital investment are expected in the coming months.

These certainly provide buffer against global headwinds. The raging war in Europe is driving up commodity prices all around. Oil prices are far above the earlier levels and is thus exerting strong upward pressure on overall prices. The average crude price fr India has surged to $105 per barrel from $85 per barrel last year.

As the RBI had noted three quarters of the current price rise is attributable to spurts in food an fuels. Supply disruptions are happening leading to occasional rises in prices of select items. These are disrupting the production processes as well.

There are widespread fears that the global economy might be entering another recessionary cycle whit had just resumed its uptick after the pandemic. India will have to maintain its growth momentum and fight the ill winds of stagflation from global economy. Not the least an easy job. (IPA Service)

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