Prof. D Mukhopadhyay, Dr Kamal Agarwal
Too much money chasing to few goods is inflation, says Harold Trevor Colbourn(1927-2015) which implies that the aggregate demand for goods and services surpasses the aggregate supply and this type of inflation is known to be demand-pull inflation caused by increase in money supply in the economy and the same is being experienced by the Indian economy for quite sometime. There is a series of disruptions in supply chain , shortage of skilled workforce and spiraling input costs to produce consumers’ items and services. The Monetary Policy Committee (MPC)’s a three day meeting , 5-7th December, 2022 recommended hike in Repo Rate by 35 basis points which stands to be 6.25%, from earlier 5.90% , as a measure to curtail the supply of money and hence inflationary pressure on the economy. The decision to raise the Repo Rate has been approved by 5:1 voting in favour and against respectively. It is noteworthy that the RBI raised the key lending rate five times in the current fiscal year so far. Since May 2022, it has increased the key rate by 225 bps in the 2022-23 Fiscal Year. It may be observed that retail price inflation came down to 6.77 percent in October, 2022 from a five-month high of 7.41 percent in September, 2022. To factually mention that it continued to be above the RBI’s acceptable limit of 2 to 6 percent for a tenth consecutive period to raise the Repo Rate for the fifth time. The Commercial Banks would certainly raise the interest rates for the borrowers and credit seekers in order to make up for the elevated Repo Rate. Home loans, personal loans and other sources of credit and financing are expected to become more expensive. It seems to be pertinent to mention that the Central Bank has also revised the GDP forecast for the third time during these 9 months in the current Fiscal Year. According to the RBI Sources, GDP for the current Fiscal Year, 2022-23 was forecast at 7.2% for April-August which was revised to 7% in September, 2022 and again it has been revised to be the 6.8% in the concluding month of the current Calendar Year. It simply means that the gulf between what should have been and what has actually been in place is quite unsatisfactory . It is quite uncertain what would be the actual magnitude of performance of the economy in terms of GDP as on 31st March of the ongoing Fiscal Year.
Inflation is a macro-economy-mismanagement- consequence which takes place due to the impact of non-controllable influences of the macroeconomic variables having adverse impact on the functioning of the global economy by and large besides, it also acts as the driver of economic adversary in domestic fronts too. Raising Repo Rate is a conventional measure to exercise check and balance on the supply of money that fictitiously foments aggregate demand . Inflation is quite certain to be in place when an economy experiences fast economic growth especially after a certain recession and the same incident happens not only to the Indian economy but the world economy at large after commencement of recovery from the catastrophic devastation caused by the Covid-19 Pandemic that eclipsed the global economic activities to a significant extent. In reality, perception of the consumers for buying at cheaper rate at any point of time may cause deferment in purchasing decision which may lead to the state of contraction in the economic activities and hence curbing inflation to the extent not beneficial to the economy should be avoidable. Repo Rate denotes the rate of interest the RBI charges the Commercial Banks when it lends money. This is a double-edged sword as such it encourages more savings at higher interest rates and more savings implies less propensity to consume leading to curtailment of aggregate demand and hence squeezing in GDP.Inflation management has been a perennial problem for India and She is a witness high inflation when the economic output level is even much below the optimum level. The worst sufferers from abnormal inflation are the marginal income earning and daily earners which argues in favour of taming inflation and keeping it within the tolerable limit. On the contrary, availability of finance and credit for the upcoming projects at the dear rate of interest normally works as a disincentive driver and ultimately it contacts the economic activities hence leading to unemployment which is likely to overcast the labour market. The monetary policy of India is observed to be more prone to control inflation since the days of adoption of market economy policy and ensuring price stability is the main objective of the Monetary Policy Committee(MPC). The MPC takes into account only the formal quantum of money supply in the circulation and it has hardly any reach over the quantum of money supply in informal circulation and the unaccounted chunk of money is one of the severe causes of inflation.
The Central Bank aims at ‘narrowing the liquidity corridor’ representing the gulf between the Repo Rate and Reverse Repo Rate and reduction of liquidity normally leads to curbing inflation. Earlier the Reverse Repo Bank Rate used to be raised by a higher margin than that of the Repo Rate in order to invite buoyancy in liquidity leading to more consumption expenditure paving the path for more economic activities. The Rise in Repo Rate means tightening money supply and hence liquidity and encouraging more saving and less consumption which creates a paradoxical situation. This needs to be overcome so that a healthy economic progress is possible and macro economic stability is in place. The point of reference for the commercial Banks is the Repo Rate at which they can borrow from the RBI. Further , the relationship between budget deficits, money creation and debt financing are mutually inclusive and equally congruent with economic growth trajectory and hence the GDP. The GDP is the effect whereas investment and employment are the causes for promoting economic activities. Therefore, an aggressive rise in Repo Rate is more likely to shrink the economy rather than doing any remarkable good in the long run.
It may sound logical that hike in Repo Rate may not act as a panacea to bring about macro economic stability as the above arguments substantiate that hard monetary policy is not not free from its limitations. Of late , due to the emergence of interest rate as an efficient variable in macro economic management, the Central bank of the country has been placing greater degree of reliance on Repo, Bank Rate, Open Market Operations(OMO) etc., rather than the earlier practice of greater dependence on Cash Reserve Ratio(CRR) alone. Further, an issue debated in the context of Central Bank autonomy many a time is the separation of debt management and monetary management functions.It may be recommended that a harmonious coordination and operation with monetary demand-supply management in order to achieve a stable interest rate environment and responsive market conditions is sine qua non for a healthy and pro-economic growth economy like India.
The MPC may take a note of the global macro economic developments due to certain geopolitical conflicts such as , Russia-Ukraine Military Conflicts, prolonged Gulf War etc and the macroeconomic implications should be amplified and embraced within an appropriately flexible and forward-looking contextual framework of inflation targets. The researchers and experts are observed to be unanimous that absence of liquidity and presence of hard monetary policy leading to the possibility of credit crunches may likely affect the macro economic stability in numerous ways and therefore, flexible monetary policy along with strong liquidity and stress free loan and credit availability accrue more benefits than the harms to the economy in the long run . The Central Bank of the country has been using OMO for sterilizing the inflows of foreign capital in order to contain domestic monetary expansion. At the same time, it is also intervening in foreign exchange markets and these actions are capable of generating favourable outcomes for economy . However, maintaining macro economic stability including price stability in the domestic market needs to be encouraged for causing more export activities and less imports and for doing so , increase in import tariff may work well in fetching the desired results. However, it is imperative to revise and ascertain the quantum of the money supply in the economy from time to time and root out the black money market so that an artificial economy dealing in black monetary transactions does not run in the economy. Though the Government of India seems to be more proactive and serious in encountering the unscrupulous market makers of black money yet more rigorous measures are recommended for.It merits mentioning that the management of liquidity poses a major challenge to the RBI and the MPC in the context of the emerging economies to which India belongs to. Therefore , the RBI may ponder over the issues argued for against raising Repo Rates to curb inflation.
(The authors are former Interim Vice Chancellor, SMVDU, J&K and Associate Professor (Finance), NMIMS University, Bangalore)
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