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RBI’s Monetary Policy Moves: Effects on India’s GDP and Inflation

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  • Post published:October 27, 2023
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Last Updated on January 23, 2024 by Kanakkupillai

At its three-day monetary policy meeting, the RBI raised its repo rate and required banks to maintain additional reserves.

This move seeks to address inflation caused by higher crude oil prices and rupee depreciation; however, inflation is forecasted to remain above its targeted 4% level.

Repo Rate Hike Monetary policy refers to the practice of managing interest rates and money supply to promote economic growth. As part of their efforts, experts appointed by RBI have formed the Monetary Policy Committee; their task is to oversee benchmark policies such as repo rates to meet this aim.

Repo rate refers to the interest rate at which RBI lends funds short-term to commercial banks in exchange for collateral such as government bonds or Treasury bills as security. Repo rates serve monetary authorities’ efforts to control inflation while also protecting their economy against overheating.

Once a repo rate increases, businesses and consumers will find borrowing from banks more expensive, creating ripple effects throughout the economy, including reduced GDP growth and inflation spikes.

Conversely, dropping the repo rate will make borrowing money from banks cheaper, which is intended for businesses and consumers. This will contribute to better GDP growth through decreasing inflationary pressures.

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Deposit Rate Hike

India’s Reserve Bank raised deposit rates – or interest banks pay on savings and fixed deposit accounts – raising borrowing costs for consumers and businesses while simultaneously decreasing money supply, potentially contributing to higher inflation rates. One of the primary goals of the RBI is controlling inflation; their target inflation level of less than five per cent should promote economic growth while creating jobs; without proper inflation control, economic development won’t occur as planned, or new jobs won’t appear within society.

The Reserve Bank of India’s decision was widely anticipated and is consistent with global trends of rising rates for longer periods and domestic concerns such as inflation exceeding target and ongoing rising vegetable prices. According to their governor, their central bank remains committed to the sustainable reduction of inflation while withdrawing accommodation – remaining committed to their “withdrawal stance.”

Fund managers and analysts expect interest rates to remain elevated for an extended period due to inflation caused by high crude oil prices and unpredictable monsoon rainfall patterns. Meanwhile, liquidity conditions continue to tighten, with restrictions being placed on foreign exchange inflows from overseas markets and RBI-linked gilt sales becoming available again.

Reserve Bank of India recently unveiled an initiative designed to enhance both security and convenience when conducting digital transactions. Their new system uses card-on-file tokenization directly at banks – improving online transaction security while safeguarding customers against fake websites attempting fraud attempts, strengthening consumer trust in India’s banking system. It marks an exciting step forward in India’s payments landscape that will facilitate easier use of digital channels while strengthening trust between consumers and banks alike.

Repo Rate Hike

Repo and reverse repo rates are two tools used by RBI to control the money supply in an economy. When inflation spikes, repo rates increase to reduce cashflow into the economy and bring prices of necessary goods and services down; conversely, when inflation decreases, reverse repo rates reduce as more funds enter and support growth; both tools work hand-in-hand to keep an economy moving smoothly and driving growth forward.

Repo rates impact all areas of the economy, yet their effect can be felt most strongly on home and car loans. A higher repo rate increases interest rates on these loans, making borrowing more costly for the borrower and having ripple effects throughout society; people will become less inclined to borrow or spend on big-ticket items due to this higher repo rate.

An increased repo rate will encourage banks to deposit their funds with the RBI instead of lending out as loans to consumers and consequently reduce money supply within the economy – an action that helps ease inflationary pressures while simultaneously hampering economic development and employment prospects in various ways.

India remains vulnerable to rising global and trade tensions that threaten price pressures and inflationary pressures in the food and energy sectors, particularly domestic demand weakness and subdued private investment levels. Due to these circumstances, the Monetary Policy Committee decided not to change repo and reverse repo rates while issuing a statement suggesting that future tightening could occur soon.

Cash Reserve Ratio Increase

CRR is one of the main strategies employed by the Reserve Bank to combat inflation. By increasing it, banks will keep more of their deposits as reserves instead of lending it out as loans; this slows economic activity by decreasing demand and prices/inflation levels.

On Thursday, RBI unveiled an increase in CRR that is intended to absorb some of the extra liquidity introduced into banking by the return of 2000 rupee notes that had been temporarily immobilized as part of an effort against counterfeit currency. Their return will add funds into circulation while leaving enough reserves intact through festivities beyond September 8 to prevent an unexpected spike in inflation.

Rising food costs threaten inflation and make lowering interest rates difficult in future years, creating difficulties for industries with sensitive rates such as banking, auto manufacturing, and core manufacturing.

Inflation has been largely driven by unpredictable monsoon rains, which have resulted in higher prices for vegetables and cereals. Capital inflows, which have created excess liquidity within banking systems, have further compounded this.

As part of its efforts to control inflation and maintain low-interest rates, India’s Reserve Bank may raise both its Cash Reserve Ratio (CRR) and Repo Rate, in addition to using bond auctions or open market operations (OMO) sales as ways of draining liquidity from the system and remove liquidity through bond sales at auctions or OMO auctions. Though such measures could push short-term rates higher temporarily, such measures will aid in effectively managing inflationary trends while mitigating any increases in food costs.

Liquidity Ratio Hike

India’s central bank, the Reserve Bank of India, is set to increase interest rates this week and push bond yields higher while tightening liquidity as wholesale price inflation remains persistently high – an indicator of their ability to effectively balance growth, inflation and capital flight issues.

The Monetary Policy Committee (MPC) maintained a hawkish tone by withdrawing accommodation, signalling its intent for rate hikes in 2018. Furthermore, its liquidity corridor tightened with an adverse bias toward banks parking excess cash with RBI.

As this will have an immediate impact on lending costs for both businesses and individuals, forcing the MPC to overcome obstructions to transmission between policy rates and lending rates – such as administrative rates, statutory preemptions or rigid deposit rate structures – the consequences would have a detrimental impact on GDP and restrict their ability to control inflation effectively.

Oil retailers recently increased petrol prices by 5.6%, and the government plans to raise diesel prices by Rs 2 per litre; both measures are anticipated to raise WPI inflation by 30 basis points while impacting CPI inflation as increased costs are passed onto consumers. Policy decisions regarding higher-than-anticipated inflationary pressures on the economy must consider how the US Federal Reserve’s decision to raise interest rates again could influence global monetary policy changes that ultimately impact India’s inflation and growth prospects.

Impact on India’s GDP and Inflation

India enjoys many advantages; favourable demographics, rising savings rates, and deeper financial sector development all work towards increasing consumer consumption. However, inflation poses additional threats that may either benefit or harm India’s economy.

Repo rate decreases make borrowing cheaper and increase spending – both of which help curb inflation.

Economics Growth Increased productivity could provide India with significant economic growth; however, doing so requires substantial investments. India will need to increase household savings rates while redirecting funds toward financial assets instead of physical ones in their savings accounts, expanding capital markets so domestic investors may expand their productive asset holdings, and increasing household savings rates overall.

India is driven primarily by domestic consumption and private investment, accounting for more than 50% of GDP. Net exports were once held back from growth but have shown improvement thanks to strong service exports as India works towards decreasing its current account deficit.

Indian monetary policy management presents unique difficulties, particularly regarding food prices, which impact inflation dynamics and create an unpredictable, ever-evolving inflation environment.

Employment Growth

India’s gross domestic product (GDP) is derived largely from services, particularly financial, real estate, and business services. Tertiary sector activities – research & development activities, as well as information technology communications and media entertainment activities that play an integral part – also contribute significantly.

Employment growth is essential to economic development; any discrepancies between GDP growth and job creation could result in so-called “Jobless Growth. “

Cyclical economies feature companies employing workers on an as-needed basis during economic downturns to balance costs against revenues, leading to temporary staff layoffs during this period. However, when the economy improves again, these former employees can often find employment again at new companies, leading to decreased unemployment overall.

India faces many employment-related barriers but also has much going for it. With a young population, high productivity levels, a deep and robust financial sector, and a positive fiscal outlook (steadily decreasing public debt), its youthful population should drive future capital investment and employment growth over the forecast horizon. A favourable fiscal environment should support this development further.

India’s economic expansion has lifted millions out of poverty and reduced global inequality over the last two decades, as estimated by the World Bank estimates (Machin & Manning 2021). According to these estimates, its population living on less than $2.15 a day has diminished substantially (Machin & Manning 2021).

Malaysia has made great strides toward becoming more service-based than manufacturing-centric in recent years, seeing service productivity hit unprecedented heights, making the country attractive to foreign investment. Yet, some unresolved issues still need attention, including labour market reform and rural development initiatives.

Consumption remains the main driver of GDP growth. It has been propelled forward by personal loan recovery – an indicator of household incomes – and faster investment activity growth. Rising interest rates, tightening monetary conditions, and elevated oil prices could impede this fiscal year’s progress, while an insufficient monsoon would limit agriculture output, further increasing food inflation.

Inflation

Inflation refers to an overall rise in prices of goods and services over time. It can occur for various reasons. Demand-pull inflation occurs when demand outpaces supply in an economy, while “printing-money inflation” also occurs when too much cash is printed to address financial crises.

As inflation rises, consumers’ purchasing power decreases while business and household borrowing costs increase – all contributing to slower economic growth overall.

Economic theory presents one of the more complicated relationships, as determining an acceptable inflation level can be extremely challenging for any given nation. Research studies have identified a negative correlation between inflation and GDP growth – as evidenced by studies showing no direct or indirect links – which makes control over inflation essential in attaining optimal economic development.

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