RBI hikes policy rate by 50 bps : Amid global turmoil, Indian economy is still ‘resilient’

That the Reserve Bank of India in its 4^th bi-monthly monetary policy review will put emphasis on control of inflation was much expected. The question was how much belt tightening will India’s central bank resort to.

This uncertainty saw the stock market jittery and the stock index BSE Sensex closed more than 500 points down on 29^th September. The anxiety was over a possible steep hike in RBI benchmark rates to match last week’s US Federal Reserve rate hike by 75 basis points. Most analysts however felt that RBI would not resort to any sharp rate hike but would raise rates by half a per cent point. When that is what RBI did stock markets heaved a sigh of relief and the Sensex recovered its loss.

The weak global economy under the continued conflict in Ukraine as also aggressive tight money policy adopted by global financial markets particularly that of the US forced RBI hand.

The US dollar is the major medium of exchange in global trade and commerce. With US tightening its interest rates all other global currencies are losing against the greenback. In fact US dollar is now at 20 year high. In order to stop such slide most countries are following the US lead and raising their interest rates as well. India for instance has raised its benchmark rates by 1.9 per cent since May 2022 in four instalments.

The record high in US rate has intensified pressures from retrenchment of portfolio flows, currency depreciations, reserve losses and financial stability risks, besides the global inflation shock. As external demand deteriorates, their macroeconomic outlook is becoming increasingly adverse. India too is facing such hiccups. However the hike in rate by RBI is not merely to shadow the US Fed or loss of rupee against the greenback in the exchange market but there are other factors as well.

India’s foreign exchange reserve has depleted by US$ 45 billion since April as RBI had to intervene in the exchange market to smoothen the fall in rupee. Apparently this and continued increase in India’s trade deficit – due to high import cost and lower export due to global slowdown – raised concerns over India’s future. But there are some silver linings amidst the concerns. RBI Governor informed that 67 per cent of the fall in exchange reserve was due to valuation changes due to rise in US dollar and not depletion due to market intervention. Central banks sell dollar from reserves in case of sharp fall in domestic currency – rupee in our case – to steady the home currency. The fact that this intervention by RBI was less than what was feared is a sign that the economy is resilient enough to withstand the global pressure. RBI governor reiterated that USD-Rupee exchange rate was not the factor behind the rise in policy rate.

RBI has not reduced the estimated GDP growth for the year drastically. Its projection of 7 per cent growth – less by 0.2 per cent than earlier estimate of 7.2 per cent – is another sign of hope. Inflation however still remains a concern. It will remain at 6.7 per cent – higher than the RBI’s band of 6 per cent. When the whole world is caught in economic cold, India cannot avoid sneezing.

What will be the immediate impact on common people? Interest rates will remain elevated causing home buyers to pay more for their home loans. Food prices may remain stable since the kharif crop sowing, according to RBI, was above normal and marginally less than last year’s coverage. That the last monsoon rains may cause some damage to the kharif crop remains a worry. Demand including rural demand is recovering and discretionary spending by consumers are reviving. The present festive season is expected to boost demand further. On the whole the Indian economy is resilient enough to withstand the global disturbance.

The Ukraine conflict has continued far too long for comfort of the global economies. But judging by the views of six experts in RBI’s Monetary Policy Committee the Indian economy has the capacity to withstand the pressure though it did not rule out further calibrated monetary policy action if the situation so warrant. Overall the RBI policy and its review provided confidence in the future trajectory of the economy.