Simply Put: Decoding RBI policy meet

Priti and Arjun overhear a conversation about RBI’s monetary policy coming up next week.

Arjun: What’s the big deal about monetary policy? Almost every quarter news channel and newspaper cover it widely.

Priti: Expect it once in two months hereon as the monetary policy committee or MPC will meet six times in FY23. The noise around it is warranted as the RBI’s monetary policy has widespread implications for businesses, policy makers and common people like us.

Arjun: How?

Priti: Just like how printing currency notes or ensuring the depositors’ interest are important functions of the RBI, enabling and ensuring a stable growth rate for the economy is also a critical function of the RBI. This is done by MPC - a team of six, including the RBI governor, but has a cross section of people from within the RBI and the outside.

Arjun: How is stability ensured?

Priti: Primarily by targeting inflation. In India, four per cent is the inflation target with +/- two percentage points bandwidth. That’s a 2-6 per cent range. In February, inflation touched 6.01 per cent, a shade above the upper limit of tolerance.

Arjun: But inflation is about cost of commodities such as power, fuel, vegetables. How can RBI monitor that?

Priti: These are factors which determine the purchasing power of people. There are two ways of influencing the purchasing power – fiscal and monetary measures. The central government takes care of the fiscal part. The RBI has authority over monetary measures – that is control over money supply in the economy. The most straightforward way of targeting the money supply or curbing inflation is tinkering the cost of money or the repo rate. It’s the rate at which banks borrow money from the RBI. If the objective of the RBI is to ensure greater supply of money in the hands of people, it will keep the repo rate low and vice-versa. But a low repo rate comes with inflationary risks as we are seeing today, and a high repo rate can lead to deflation or stagflation. Repo rate has been at 4% since May 2020.

Arjun: But the people here are sayingthat the rates will go up.

Priti: Interest rates should balance between growth and inflation. Usually, economies with higher inflation are assumed to grow faster than the rest. But now with the geopolitical tension and steep increase in crude oil prices, the equilibrium is disrupted. So, higher inflation won’t naturally mean faster economic growth. In fact, rating agencies are downgrading India’s GDP estimates for FY23 because of inflation. What’s happening now is that despite money being cheaper for consumption, people are unable to spend as they used to before the pandemic because of high inflation. So low interest rates is not doing the job it has to do in an effective way. A prolonged cheap money situation and high inflation can be a lethal combination and warrants for a rate hike. There’s one more reason. Much of money supply into emerging markets (EMs) including India are dependent on the stance that western nations take, mainly the US. The US Federal Reserve, equivalent of the RBI, has decided to increase its benchmark rate by 0.25 per cent in March, effectively putting an end to its ‘zero’ rate policy. This is the first hike since 2018 and it was essential because of inflationary pressures the US is facing. In fact, inflation is becoming a global problem.

Arjun: How does Fed impact India?

Priti: A rate hike by Fed may prompt investors in the US to increase their exposure domestically rather than in EMs because the returns locally may be higher than the outside markets. So, when money moves out of India, which already is happening, it causes an imbalance in rupee-dollar exchange rate. Weakening rupee could put more pressure on crude oil as we import them, thereby leading to higher inflation. So, an indirect counterbalancing measure, a rate hike is likely even in India.

Arjun: But what is in store for me?

Priti: Remember when you took the car loan at seven per cent and your dad cribbed about coughing up 14 per cent interest six years ago for the car loan? All these are dependent on the MPC’s decision about the repo rate. Low repo rate means cheaper loans; and low interest income on deposits. If the repo rate increases, your loans could cost more, though the money deposited in banks may fetch more interest. Basically, it’s a cue to plan your finances.

Arjun: Got it, so borrow (or spend) wisely when the rates are low and conserve (or deposit) money when rates are high.

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