NEW DELHI: A stubbornly high inflation and persistently falling rupee promoted the Reserve Bank of India's (RBI) monetary policy committee (MPC) to raise benchmark lending rates for the 4th time in a row on Friday.
The MPC, comprising three members from the RBI and three external experts, raised the key lending rate or the repo rate to 5.9% - the highest since April 2019.
Since the first unscheduled mid-meeting hike in May, the cumulative increase in interest rate now stands at 190 basis points.
The RBI governor also pointed out that the MPC takes into account domestic factors on inflation and growth while formulating its rates strategy. In light of this, he highlighted few major factors troubling not just India but the global economy as a whole.
Here's a look at the factors and how they influenced RBI's rate hike decision:
* Covid-19 pandemic
The RBI governor cited Covid-19 pandemic as the first major shock which brought about a major slump in growth trajectory of almost all major economies of the world.
With countries closing their border for travel, trade and pretty much everything, the supply-side shock was soon felt by all economies.
The world saw biggest lockdowns ever, which ultimately impacted domestic growth and posed a huge challenge. As business activities came to a halt, unemployment was high and wage rates fell to all-time lows.
Therefore, it became inevitable for the central banks to reduce their benchmark lending rates and focus on maintaining liquidity to be able to support growth. In line with others, RBI too slashed repo rate to 4%, and maintained it at the same level for next 2 years, until it was sure that the economy is out of doldrums.
* Russia-Ukraine war
Just when the world was gradually recovering from the slump creating by the pandemic in last 2 years, the world faced yet another major setback. Russia's invasion of Ukraine impacted the global economy adversely.
Not only was it a setback for the 2 countries but the spillover effects arising from the seizure of 2 important trade routes, wrecked havoc for many.
Directly or indirectly, the conflict in Ukraine raised the prices of a vast range of things – from food and cooking gas, soaps and cosmetics, cars and city transport, steel and aluminium, to flight tickets and shipping freight.
Besides, the huge number of sanctions imposed on Russia by the US and its allies made matters worse. Russia was a major producer of some essential commodities. It produced not only 17% of the world’s natural gas and 12% of its oil, but supplies 6% of the aluminium too. It also produced 43% of the world’s palladium, a white metal used in a range of products including car exhausts, jewellery, and dental fillings.
As a result, Brent crude prices surged to record highs with the spillover effect of this coming as a blow for all. Even though India depended on Russia for just 2% of its oil needs but the overall hike in prices meant spending a higher amount for each barrel purchased. Therefore, oil and vegetable prices contributed majorly to the surging inflation in the country.
* Persistently high inflation
Retail inflation remains elevated and above the upper tolerance band of the target due to large adverse supply shocks, some firming up of domestic demand, and the spillovers from global financial markets. Recent corrections in global commodity prices including crude oil, if sustained, may ease cost pressures in coming months, the RBI governor said earlier in the day.
High commodity prices in global markets had a negative impact on overall inflation levels in India. In April, the consumer price inflation surged to 8-year high of 7.79%.
This prompted the RBI to take immediate action and in an off-cycle MPC meet in May, benchmark lending rates were hiked for first time since August 2018. The rate hike decession was taken at a very uncertain time as there were twin challenges of whether to support growth or tame inflation. And, of course RBI opted for the 2nd option.
In today's policy announcement, RBI retained the retail inflation forecast at 6.7% for 2022-23. Consumer price inflation (CPI) accelerated to 7% in August, driven by a surge in food prices, and has stayed above the RBI's mandated 2-6% target band for eight consecutive months.
In other words, even after 4 rate hikes, inflation continues to remain stubbornly high - a phenomenon that is affecting much of the global economy.
* Aggressive monetary policy stance
The RBI governor termed aggressive monetary policy stance being adopted by central banks of other major economies as a "storm" and said that even though the current global scenario demands such actions, these eventually lead to negative externalities through global spillovers.
"Now we are in the midst of a third major shock – a storm – arising from aggressive monetary policy actions and even more aggressive communication from advanced economy (AE) central banks. The necessity of such actions is driven by their domestic considerations, but in a highly integrated global financial system, they inevitably cause negative externalities through global spillovers," Das said.
He further highlighted that sharp rate hikes and forward guidance about further big rate hikes have caused tightening of financial conditions, extreme volatility and risk aversion.
"The global economy is in the eye of a new storm," Das added.
* Depreciating currency
The US Federal Reserve's relentless and aggressive rate hikes over recent months to curb inflation have battered the rupee, and most other emerging and developed market currencies.
Policymakers around the world are grappling with a sweeping shift away from their respective currencies and into the safe-haven dollar, raising worries of capital outflows and further damage to their economies.
RBI governor said the movement of the Indian rupee has been orderly compared to most other countries. It has depreciated by 7.4% against the US dollar during the same period – faring much better than several reserve currencies as well as many of its EME and Asian peers.
During the current financial year (up to September 28), the US dollar has appreciated by 14.5% against a basket of major currencies, he added.
