RBI’s repo rate dilemma

The Reserve Bank of India’s Monetary Policy Committee (MPC) faces a Hamlet-like dilemma on whether to raise the repo rate or not today when the decision on policy rates is announced, given the global headwinds and local macroeconomic challenges.

The current repo rate (the rate at which banks borrow from the RBI) of 6.5% has remained unchanged for three consecutive policy announcements since its increase from 6.25% to 6.5% in Feb 2023.

Global scenario

The US economy is bouncing back, strengthening the dollar against the rupee, which has fallen nearly 10% between February 2022 and February 2023—from Rs 75 per dollar to Rs 82.64 per dollar. It is Rs 83.25 per dollar as of yesterday. Considering the Federal Reserve’s continuous interest rate hikes, a repo rate increase is necessary to stabilise the rupee and safeguard bond yields. The global growth outlook is grim due to continuous monetary tightening to arrest spiralling inflation in the advanced and emerging economies, Eurozone countries like Germany and France facing recession, China’s slowdown, and rising crude oil prices—from $80 per barrel a few months ago to over $85 per barrel as of date—pushing global inflation into a spiral.

Local macro dynamics

Consumer Price Index (CPI) inflation, a key factor in the RBI’s policy decisions on interest rates, remains a concern.

Although CPI inflation (including food and fuel) eased to 6.83% in August (7.44% in July), it is higher than the RBI’s upper tolerance limit of 6%. This is mainly due to a fall in vegetable inflation. But the real concern is on two counts: first, inflation is still elevated for cereals (12.4%), pulses (13.2%), and milk and milk products (10%)—the brunt of the higher prices faced by the common man.

Second and more serious is rural inflation, which is stubborn at 7%. The rural distress will affect consumer demand, growth, and employment. The uneven distribution of rains during the last two months has affected both agricultural production and the sowing of certain crops. This partial El Nino effect triggers inflationary pressure.

The surge in global Brent prices, over $85 per barrel, not only affects our import bill (80% of our total imports), affecting macro parameters, but also contributes to domestic inflation via higher fuel and freight prices. The ‘imported’ inflation will feed into the domestic CPI, disturbing the growth dynamics and inflation trajectory adversely. Though the bank credit offtake has increased to 19.7% year-on-year at Rs 148.8 lakh crore as of August 11, the spike is due to HDFC’s merger with HDFC Bank and growth in personal loans and lending to NBFCs. Otherwise, the credit growth is only 14.8% YoY.

What is more disturbing is the shrinking ‘affordable housing’ segment to 20% in the half-year 2023 (April–September) from 23% in H1 2022 as a proportion of the total housing supply. That 46,650 units were sold under affordable housing against total sales of 2.29 lakh residential units (ANAROCK research) is a matter of concern.

The continuous rate hikes by the banks and HFCs on account of repo rate hikes by the RBI until 6 months ago have resulted in an increase in EMIs by nearly 20% for earlier home loan borrowers, and the prevailing high rates above 8.5% for new borrowers have affected the demand for housing. The rates will stay higher for a longer period of time.

This sector needs a great push both from the demand and supply sides, especially during the upcoming festive season of Dasara, Dhanteras/Deepavali, Christmas, and the New Year, to facilitate the buying of apartments with builders offering attractive schemes and incentives.

Systemic liquidity has been in deficit to the extent of Rs 1 trillion since September 18 to keep ‘Arjuna eye’ on inflation to maintain price stability. The RBI’s reduction in the incremental Cash Reserve Ratio (CRR) until October 7 and government spending will ease the liquidity pressure.

Keeping in view the above critical issues, the impact of ‘freebees’ during the election year (election inflation! ), the surge in crude oil prices, and unabated rural inflation, it would be appropriate for the MPC to raise the “repo rate” by a minimum of 25 bps to arrest the inflation spiral and to signal a red flag to the central government and states not to indulge in fiscal profligacy.

But the MPC for now may adopt a wait-and-watch approach by maintaining the status quo in the repo rate at 6.5% to support the nascent growth and not be a villain in the piece!

(The writer is a former banker)