The Reserve Bank of India has done a delicate pirouette in formulating its monetary policy in the context of extreme volatility and uncertain turn of events. All that RBI has done on Wednesday is to raise the policy interest rate – called the repo rate – by half a percentage point. This rate hike comes on the back of another hike just a month back on May 4 by 40 bps. In effect, the two hikes together raise the interest rate by close to 1%. The Central bank has left other levers like the cash reserve ratio (CRR), which is the portion of money commercial banks leave with the central bank, unchanged. Additionally, RBI has done some liberalisation with subsidiary banking systems, like the cooperative banks, which should help the greater flow of funds into select sectors of the real economy.
Policy formulators and managers are facing a dilemma. Prices are rising currently at a faster than comfortable pace. Maintaining price stability is the first charge of the Reserve Bank and by doing this two-sage hike in the basic policy rate, India’s central bank has demonstrated its commitment to maintaining price stability. That is important if one remembers what is happening in neighbouring Sri Lanka or Pakistan. Prices in these neighbourhoods are rising so fast that the price of items of daily use could fluctuate by even 50% between morning and evening. At the same time, the Indian economy is recovering from its worst trauma in recent times, the pandemic. Just to remind only, in 2020 the Indian economy had contracted by a quarter in a single quarter. We are now again growing and India is billed as the fastest-growing major economy. That’s a hard task, given the way the global economy is turning and there is uncertainty. So, it is important to egg on that growth stimulus with proper incentives.
Interest is the price for money that there is a market where banks lend and borrow from among themselves to tide over temporary – that is, overnight – shortages of money or excess of it. This is called the overnight call money market. The call money rate currently (June 8) hovered around 3%. Since the repo rate is at 4.5%, it means that the Indian financial system is having excess liquidity. Ordinarily, as deputy governor, D Michael Patra of Reserve Bank explained in the post-policy press interaction, this was at the floor of the liquidity corridor. In one simple word, the system is flush with funds. Commercial banks are parking excess liquidity to the tune of Rs 5.5 lakh crore in overnight deposits with the RBI. It is against this background that the RBI Governor, Shaktikanta Das, said that he would pursue a policy of normalisation of monetary policy and withdrawal of accommodative position. This is important for overall financial stability as well as for inflation control. Too much money in the system would result in race pressure and hence these should be rough down normal levels. Being a conservative institution the RBI is, the Central bank has assumed a growth rate of 7.2% for 2022-23.
