The Reserve Bank of India-led Monetary Policy Committee (MPC), in its off-the-cycle meeting, has raised the repo rate — the rate at which the Central bank lends — by 0.4 per cent or 40 basis points and increased the money that banks are required to park with the RBI by 0.5 per cent or 50 basis points. The monetary tightening after four years of an easy run is aimed at reining in stubborn inflation and preparing the Indian economy to navigate in the global high-interest rate scenario.
While the RBI had indicated that its focus would shift to inflation management instead of economic growth, many stakeholders did not expect the RBI to be so aggressive in its approach. Since inflation was primarily driven by supply constraints, many analysts and investors believed that the RBI would be easy on monetary tightening. However, the central bank’s decisions, apart from making borrowing funds from it costly, would suck out Rs 87,000 crores from the Indian banking system, worsening the impact on borrowers.
The RBI decision shook the Indian equity markets, with the Sensex losing over 1,300 points and the Nifty shedding over 300 points. The hit was Rs 6.7 lakh crores on the wealth of investors. It invited a barge of criticism from investors, who complained of inadequate communication from the central bank about its intent, while several corporates were worried about the rising interest rates adding to the multitude of woes that they are facing in the aftermath of the Covid pandemic, rising commodity prices, shortage of raw materials, increasing shipping costs, the shrinking buying power of consumers, and uncertain geopolitical and geo-economical landscape.
A look at the global interest rate map would allow one to understand the reason behind the RBI’s unexpected move to hike interest rates. Except for China, the Eurozone and the countries which see the insignificant flow of foreign funds, all countries have increased their policy rates. Hours after the RBI’s rate hike announcement, the US Federal Reserve hiked its policy rate by 0.50 per cent or 50 basis points — the most aggressive since 2000. It also announced the reduction in its $9-trillion balance sheet, which would further accentuate the rate hike impact on the borrowers. Immediately after, the Bank of England too increased its policy rate by 0.25 per cent or 25 basis points to make the cost of borrowing the highest in 13 years.
This is the global policy background in which the RBI had to operate. Whether the RBI rate hike would cool down supply-shortage-driven inflation is clearly unknown, the higher rate would surely prevent the flight of investors, who look for an interest rate arbitrage to invest in countries that have developing economies.
A growing economy, lower inflation, interest rate arbitrage and policy stability are the key factors that foreign investors look for before investing in an emerging economy. Persisting with a lower interest rate when the economic rate is not greatly enticing could be suicidal if the foreign investors flee the country as they had in 2013 — colloquially referred to as the Taper Tantrums. The RBI’s decision, though it pinches every pocket, was the need of the hour for the greater good of the country. The lower interest regime in the country is all but over....