In response to persistently high inflation, the Reserve Bank of India (RBI) announced a 50 basis point increase in the repo rate on September 30. September 28 marked the beginning of the three-day meeting of the Monetary Policy Committee (MPC).
By a majority of five out of six, the monetary policy committee (MPC), which consists of three members from the Reserve Bank of India and three external members, raised the key lending rate to 5.90%.
As US Federal Reserve interest rate hikes have significantly devalued the rupee and prompted most economists to predict another 50 basis points increase. As a result of these three recent meetings, the MPC has raised rates by a total of 140 bps, including two consecutive moves of 50 bps.
As a result of higher food prices in August, the annual retail inflation rate accelerated to 7%, and it has remained above the RBI’s mandated 2-6% target band for eight consecutive months.
In a report, Morgan Stanley has also said the MPC is likely to increase the repo rate by 50bps, to 5.9 per cent, with an unchanged stance. On inflation, Morgan Stanley said it has been range-bound around the 6-7 per cent mark since January 2022 (barring April 2022).
“We expect inflation to remain sticky around 7.1-7.4 per cent in September as well, driven by increases in food prices as per high-frequency food price trend. Thereafter, we expect the trend to moderate but remain above 6 per cent until Jan/Feb-23,” Morgan Stanley’s report noted.
In the wake of the Ukrainian war, rising energy prices, and lingering supply-chain disruptions, central banks in advanced and emerging economies are raising interest rates almost in lockstep.
To reduce the money supply in the economy, central banks typically raise the benchmark repo rate – the interest rate at which commercial banks borrow money from the Reserve Bank by selling their securities.
Across the globe, countries are aggressively raising lending rates in an effort to curb the supply of cheap money and reduce inflation. The trade-off faced by most nations, including India, is that such monetary tightening dampens investment, cost jobs, and suppresses growth.
At an unscheduled meeting in May, the RBI raised interest rates by 40 basis points, followed by 50 basis points in June and 50 basis points in August. A basis point equals one hundredth of a percentage point.
“India is better placed than many economies, but if high inflation is allowed to remain, it exacerbates second-order effects.”
The overarching focus is on “maintaining macroeconomic stability”, the RBI governor said.
Global growth is slowing sharply, with further slowing likely as more countries fall into recession. According to the World Bank, a recession is likely to occur in 2023. In a statement, David Malpass, President of the World Bank Group, expressed his deep concern that these trends are likely to persist, resulting in long-lasting consequences for emerging market and developing economy residents.
By tightening monetary policy unrelentingly in order to control inflation, the US Federal Reserve has boosted the dollar and bond yields, scaring other currencies, including the rupee. As a result of a strengthening dollar, the rupee’s value has been eroded. The RBI has been intervening in the markets to support the rupee by selling dollars from India’s foreign exchange reserves.
“There has been a 67% decline in reserves due to valuation changes arising from an appreciating dollar and higher bond yields. The market intervention will continue to be judicious,” Das said. He implied that the RBI will take a measured approach to the extent to which it will defend the rupee.
The country’s precious foreign exchange reserves stood at $537.5 billion on Sept 23.
A current account deficit (CAD) in the first quarter of 2.8% of GDP and a trade deficit of 8.1% point to “weakening global growth and consequently trade deficit remained high”, Das said.
The term CAD refers to the difference between the amount India spends in the rest of the world and the amount it earns.
It should be noted that services exports continued to grow, with an increase of 35.4% from April to June compared to 22.6% for remittances. This net surplus in services export is expected to offset a portion of the trade deficit, according to the governor of the RBI.