Manivel's Blog

Can RBI policy rate hike help control Inflation

RBI has raised the policy rates for the fourth time this year (refer table for the change in 2010)

Date Repo (%) Reverse Repo (%) Increase (bp)
19/03/2010 5.00 3.50 25
20/04/2010 5.25 3.75 25
02/07/2010 5.50 4.00 25
27/07/2010 5.75 4.50 25-Repo     50-RR

As the RBI Governor Mr. Duvvuri Subbarao says, the policy rates are being hiked continuously for the fourth time to control the double-digit inflation and to have a sustained economic growth.

The inflation has been in double-digits for the past 5 months (10.55% in June) and the food inflation went above 12%. This was mainly due to demand side pressure and shortage of food grain supplies due to poor monsoon. The policy rates increase are on the expected lines. RBI is pursuing its declared policy of calibrated increase in rates to ensure reduction of funds in the system without affecting the growth process. Without touching CRR (Cash Reserve Ratio), RBI ensures that the economic recovery from the global downturn is not hampered. Subbarao has bet on the monsoon to control the food inflation expecting it to cool down with the increase in supply in the coming monsoon.

Though the RBI has hiked the rates, economists believe that the commercial banks may not change its lending and deposit rates immediately as this much increase is factored by the banks while some do believe that there would be marginal increase in the lending rates by the banks. The issue over here is if the banks do not pass on the rate changes, RBI would not see any effect in inflation as there is a general increase in public spending and the banks could earn more from lending loans than depositing with RBI.

With the jobs market back in action, in India and the whole economy recovering, requirement for credit for expense would keep increasing and thus raising the inflation as well. Also, depending on the monsoon for to control the food inflation is not a good measure that a government can take.

Though increasing CRR is not favored, a marginal increase would remove some liquidity in the market and would help cool the inflation. There is also a need to understand that inflation is a part of a healthy economic growth and once the economy matures such factors would be absorbed.

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This entry was posted on July 30, 2010 by in Economy.

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