THE Reserve Bank of India (RBI) has followed the global script of tackling rising inflation by going for a hike of 25 basis points in the repo rate. The first hike in interest rate since February 2023 is a signal of the end of the era of low inflation. A tighter monetary policy is set to be the order of the day as indicated by the RBI Governor Mr. Sanjay Malhotra and the unanimous stance adopted by the Monetary Policy Committee (MPC) to take the repo rate to 5.50 per cent. The rate hike has made it clear to the country that inflationary concerns are bound to dictate future monetary policy decisions to keep the overall growth rate intact.

 

The six-member MPC was banking on easing tensions between the United States and Iran and normalcy returning to the Strait of Hormuz. The positive sentiment of the last meeting has turned hawkish as things have gone south in the West Asia conflict. With no resolution in sight in the near future, central banks have gone back to a guarded stance through rate hikes. With the onset of the festive season, the rate hike is a prudent decision as the crude oil imports would directly affect consumption which was the biggest driver of growth in the previous quarter. Imports at a higher price and lower consumption that too in a festive season will be a double whammy for the economy, affecting potential growth in the longer run.

 

The rate hike will certainly affect home loans, debt bonds and vehicle loans as banks will pass on the higher interest rates to the customers but it was a necessary step to control larger inflation. Till now, the central bank was of the view that an increase in interest rates would have been a redundant exercise when the growth rate was peaking steadily. It was thinking of keeping the inflation around its required band with structured liquidity into the system. Money in the system was necessary to keep the manufacturing cycle going. Luckily, domestic consumption had picked up in the last few quarters helping companies to increase production. But now, with global headwinds getting stronger, there is a danger of overproduction and less consumption despite more liquidity in the system. These factors are bound to cast effect on food and retail inflation. The RBI is in no mood to allow inflationary dangers affecting its growth projection. The repo rate hike was the only tool it had to arrest the threat. However, the markets had already priced in the rate hike. It did not react too much to the 25 bps hike as the volatility was largely driven by geopolitical reasons. The bond market responded by driving up yields and the exchange rate largely responded to dollar outflows and elevated oil prices. Though the RBI has not clearly stated its position on rate hike in the future, the talk of calibration by Mr. Malhotra indicates a cautionary stand against effects of inflation. Another hike in the interest rates is a real possibility if global tensions do not subside till the next quarter.

 

The Governor has put it down to evolving macroeconomic dynamics to determine how deep or shallow the rate hike would be during his address. Therein lies the catch. A lot of activities are lined up this quarter that will determine macroeconomics. The Kharif yield will be out in a few days. With the monsoon playing truant in many parts of the country, it is expected to be a subdued season for foodgrains production. Many regions have already declared drought and the high possibility of a Super El Nino system further makes things difficult in the upcoming Rabi season. Combination of all these developments will have a direct effect on retail inflation. Though the general trend in the country during the festive season remains positive about consumption, how the markets react after the festivals will play a key role in defining macroeconomic dynamics for the RBI. Of course, that is for the future and many other global developments will also be responsible for influencing the MPC thinking. For the time being, tightening monetary policy is a requirement, given the current conditions.