Retail inflation figures for June 2024 were released on July 12 recording a rise after three months of steady decline igniting hopes of a rate cut by the Reserve Bank of India (RBI). While retail inflation fell from 5.09% in February to 4.85% in March, 4.83% in April and then to 4.8% in May, it rose to 5.08% in June.
Food inflation the villain
Incidentally, the rise in retail inflation was driven by an uptick in food inflation, which rose from 8.69% in May to 9.36% in June.
But how are retail inflation rates going to determine our EMIs?
There is a significant correlation between the pace of inflation in a country and the prevailing interest rates. Interest rates are certainly not dependent only on inflation, but the latter is an important determinant of interest rates in any economy.
No relief unless inflation declines
Abhirup Sarkar, former professor of economics at ISI Kolkata feels that it would push back the time when RBI could contemplate a reduction in interest rates. “None would get any relief unless the rate of inflation goes down,” said Sarkar.
“Inflation is a major determinant of the interest rates in the country. The RBI governor has repeatedly warned about the pernicious effects of high food inflation,” said investment strategist Nilanjan Dey, director Wishlist Capital.
Repo Rate has to be reduced
Significantly, RBI wields a hold on interest rates by controlling the Repo Rate, which is the rate of interest at which the central bank lends to commercial banks. To raise money supply in the market during the pandemic, RBI raised Repo Rate from 4.0% in April 2022 to 6.5% in May 2023.
Since April 2023, the key rate has been maintained unchanged at 6.5%.
Why EMIs won’t decline
Here lies the connection between EMIs and inflation. If the RBI reduces the Repo Rate, the cost of funds for banks goes down and, as a direct outcome, banks reduce the interest rates on the loans they give to both retail investors who take home loans, car loans and personal loans and businesses.
Therefore, if the cost of capital goes down, the interest rate on loans will go down, which will reduce the burden on both the common man through a reduction in EMIs on future loans as well as on current EMIs since almost all loans are issued on floating rates of interest.
US Fed caught in same bind
Right now Jerome Powell, the chairman of the US Fed has also said that they are not going to reduce interest rates unless inflation rates don’t come close to 2%, which is the long-term goal of the US central bank.
The long-term goal of the RBI is to bring retail inflation to 4%. RBI governor Shaktikanta Das has made it clear that it will not risk reducing interest rates right now to risk inflation being stocked further.
The case for interest rate reduction
While the common man wants desperately EMIs to come down, businesses want the cost of funds to come down since it would raise consumption. A decline in interest rates on loans taken by companies would also help them take working capital or term loans at cheaper rates.
It would infuse life in the economy and could even spur growth rates, experts think. But for any central bank, controlling inflation is one of the priority areas.
In fact, there is a growing voice in the six-member Monetary Policy Committee (MPC) of the RBI that Repo Rate should be trimmed by 25 basis points. Though external members have started pressing for it, RBI members are firm to wait and watch the way inflation moves before taking the decision.
The MPC meets once every two months to take stock of the situation and review the key policy rates.
Unless inflation eases, it is highly unlikely that the Reserve Bank of India will reduce interest rates. All our EMIs are dependent on the key policy rates. Economy Business News – Personal Finance News, Share Market News, BSE/NSE News, Stock Exchange News Today
