New Delhi: RBI Governor Shaktikanta Das has once again left interest rates unchanged at 6.5 per cent while mentioning that food inflation is something the central bank will be closely watching. However, can the central bank do much about food inflation? Unfortunately, no.
Headline inflation vs interest rates
Since the Russia-Ukraine war started in 2022 and global inflation went through the roof, central banks across the world, including the Reserve Bank of India, started the interest rate hike cycle. India stepped up the repo rate, or the rate at which banks borrow from RBI, from 4 per cent to 6.5 per cent – a 250-basis points hike in just 6 cycles.
As a result, the inflation was tamed from a high of nearing almost 8 per cent to about 5.4 per cent for FY24. RBI wants to hammer it down to 4 per cent. But right now, inflation is not as much because of more demand in the system that RBI can control by getting people to put more money in the bank to get higher interest. What is causing inflation to remain sticky is actually food inflation. The central bank can’t do much about it.
Let me explain. If there’s a bumper harvest season, then there is more supply for the same amount of demand. Sellers will have to keep prices low to sell their produce. However, if there is a lower farm output for the same demand, sellers will be able to hike prices, leading to inflation. So, food prices are basically dependent on the total farm output, plus the cost of transporting it, and the damage incurred in logistics.
Monsoon plays the most important role in determining the output quantity – the RBI can’t control it. Fuel Prices determine the cost of transportation – which is again outside of the central bank’s rate decision; and climate along with warehousing plays a role in the wastage of food – nothing that monetary policy do about it.
Veg thali gets costlier
In the month of May, the cost of the veg thali went up by 9 per cent on account of around a 40 per cent increase in the prices of onion, tomato, and potato from a year ago period. Add to that a 13 per cent increase in rice and the veg thali now costs almost Rs 28. But that could change and, the RBI won’t have a role to play in it.
This year, the Indian Meteorological Department has predicted above normal rainfall. That means farmers should see better production volumes, so food inflation should naturally come down. Remember – RBI’s job is meant to be preemptive, not reactive. Rate decisions taken today will see an impact only a month or two later.
So not cutting interest rates today, despite a good monsoon prediction may be counterproductive. The obvious question then is why isn’t the RBI’s cutting rates?
The name is ‘Bond’
One answer could be that RBI is waiting for the US Federal Reserve to first cut rates. See, interest rates and bond prices move in opposite directions. So, if RBI cuts rates while US Fed doesn’t, then the Indian bond market will become expensive and money will flow to the US. RBI doesn’t want that to happen, so it is keeping what is called the ‘spread’ intact. More money coming into India’s bond market will help RBI to make more money.
However, there’s a flip side. Cutting rates will not just make your loan EMIs lower – it will also reduce the borrowing cost for companies. If the cost of capital reduces, companies will be able to take larger loans that they have been deferring for invest in capital expenditure like new offices and factories. So, a lower interest rate will help corporate India invest in job creation, which will in turn lead to more income and greater demand. Overall, a good trajectory for the economy. So, is the RBI favouring inflow of money through bonds over private investment and job creation? I’ll leave you with that thought.
The Reserve Bank of India has kept the repo rate unchanged for more than a year now at 6.50 per cent. However, the rationale of keeping food prices in check does not hold water since food prices are a function of weather and farm output, which are beyond RBI’s control. Economy Business News – Personal Finance News, Share Market News, BSE/NSE News, Stock Exchange News Today
