Will Governor Shaktikanta Das go the way of Fed, this is the reason behind increasing interest rates

A recent chart prepared by Rahul Bajoria of Barclays showed that India’s inflation volatility is very low compared to emerging and developed economies.

Reserve Bank of India

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Monetary Policy Committee of the Reserve Bank of India (RBI MPC) Has decided to increase interest rates by 35 basis points. Well there is nothing surprising on this growth. However, the rate hike (Repo Rate Hike) There were different views among the MPC members regarding Recent statements suggest that the decisions of the MPC are based on the US Fed rather than on domestic inflation. (US Fed Reserve) are governed more by the decisions of This is surprising, because the inflation dynamics in the US are very different from those in India. Moreover, inflation in the US is much higher than the target, while in India it is still at the tolerance level of 6 per cent.

India’s inflation volatility is very low

A recent chart prepared by Rahul Bajoria of Barclays showed that India’s inflation volatility is very low compared to emerging and developed economies. Also, the issue is whether the issue of growth has been left behind in order to bring down inflation. The Reserve Bank of India’s estimates will be closely watched in the coming days and it is certain that future working papers will attempt to answer this question.

Nearing the end of the current rate hike cycle

However, it is a welcome sign that the rate hike has slowed down. This shows that we are nearing the end of the current cycle of rate hikes. However, the RBI’s track record of inflation forecasting has been spotty and any error in inflation forecasting will impact growth. Especially at a time when growth is expected to slow down worldwide and even in India.

Is the Fed Governor’s statement

The RBI itself slashed its growth forecast despite the MPC raising interest rates, while the governor talked about inflation spreading across the world as business slumped. So, there is some analytical inconsistency here, especially in the context of India’s economic reality.

Take for example the statement made by the Fed governor, where he mentioned that reining in inflation is not a big risk as he can always cut interest rates. But it works in America because the spread of interest rates there is smooth. The same cannot be said for India, where the spread of monetary policy often wobbles.

Did RBI want an increase of 0.50 percent?

As a result, if we take more stringent measures, recognize the mistake and then start cutting interest rates midway, the impact of the rate cut will take its own time to integrate into the system. The reality of the rate spread gap with the general weakness in global economic growth is probably a wait-and-watch approach. The MPC probably wanted to hike rates by 50 bps but considering these realities, a 35 bps rate hike was decided.

may be overcorrection

Needless to say, the analytical framework of the MPC is appropriate in the current context, but the stringency with which it interprets the 4 per cent inflation target and its imbalance with the upper tolerance level to keep inflation above target during the pandemic is significant. There may be a process of overcorrection. However, the extent to which inflation can be controlled through rate hikes remains a debatable issue.

It needs to be recognized that the bigger risk in the context of the Indian economy is not too little control, but too much control. Therefore, it would be useful to hold off on the current rate hike and allow the spread while waiting for more data on growth and inflation data.

Lower terminal rate required than anticipated

If the past few weeks are any indication, global price pressures are easing, so this will help tackle domestic inflation. Therefore, the terminal rate would be required to be lower than anticipated at the outset of the rate hike. Also, if global economic slowdown sets in in FY 2023-24, global demand for commodities (outside China) is likely to weaken and this will reduce the pressure on commodity prices.

Inflation will come at the level

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And all these will help in fighting inflation and this fact is independent of rate hike of MPC. And perhaps this will bring the inflation rate back in the range of 2-6 per cent. So, we come back to the sacrificial rate and ask how much growth have we sacrificed in 2022 and in return how much inflation has come down due to the interest rate hike? Hopefully in future we will have many research papers which will try to answer this question.