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The Latent Image of Inflation in India

The advent of covid made the economies paralyzed across the world; it even threatened the existence of life of human beings. Due to the stormy disruption in the supply chain, countries witnessed a surge in the inflation rate and India was not an exception. Even before the pandemic hit Indian inflation rate was above the mandate but covid has made the situation worse. In India’s condition inflation has remained high across the spectrum and Russia- the Ukraine crisis mounted the problem. Edible oil and fuel prices skyrocketed and it put the survival of people more difficult. Amid these happenings, RBI surprised the nation and international players by increasing the repo rate and cash reserve ratio by 40 to 4.4% basis points and 50 basis points to 4.5% respectively. On the same day, the US federal reserve bank also came into the picture by making a hike in the rates by 50 bps. A move that is intended to control the retail inflation in the market by tightening the liquidity of the market is witnessing various criticisms. The consequences can be observed by looking at the fact that this decision slumped the BSE Sensex market plunging more than 1400 points.


Surging inflation will put the health and life of people in danger, and escalated war between Russia and Ukraine would lead to a hike in fuel prices in India, the price of edible oil has risen from Rs. 125 to Rs. 170-180 within one month only. Amid these statements, RBI on Wednesday surprised the nation and international players by increasing the repo rate and cash reserve ratio by 40 to 4.4% basis points and 50 basis points to 4.5% respectively. On the same day, the US federal reserve bank also came into the picture by making a hike in the rates by 50 bps. A move that is intended to control the retail inflation in the market by tightening the liquidity of the market is witnessing various criticisms. The consequences can be observed by looking at the fact that this decision slumped the BSE Sensex market plunging more than 1400 points.


The Repo rate is the rate at which the commercial banks borrow from the RBI. It has a negative relation with the stock prices in the market as its rising repo rate prompts the companies to cut the expenditure which subsequently leads to a slow growth rate and in turn results in a decline in the stock prices. But the question here arises about how this move will impact the Indian market and inflation. Presiding inflation in India was driven by the consumer expenditure on goods and services as in India inflation is benchmarked by CPI, not by WPI. Further, the impact of change in repo rate is more visible in the capital intensive sectors than the other sectors such as FMCG, IT sectors, and others. So here comes the contradiction: will it not lead to a collapse in the capital market only?


Inflation is observed when there is excess demand in the market. The starting point of this theory demonstrates that it's an excess output over its natural level. Taking it forward it's a counterpart of the full employment theory as if the economy is at full output level then the economy is deemed to be at the full employment level. The west-central banks before they adopted the inflation targeting policy were following a tangible measure of the inflation that was something like “growth of the money supply”. Talking in the context of India where this inflation is pushed by the agricultural commodities and imported food oil this monetary policy would not help much. To curb inflation we should be more focused on the supply side rather than the demand side by increasing the supply of agricultural products. There is another route for that is to curb the growth of non-agricultural goods which would, in turn, result in a decline in the demand for agricultural goods and that would make a cycle and consequently, inflation will control. Now coming to another aspect is the diversification of the agricultural produce as the growing per capita income in India has shifted the average consumption basket towards food rich in minerals, such as fruits, vegetables, and proteins such as milk. The supply of these commodities has been lower for a long time as the farmers are not getting incentivized to cultivate these crops.


The cash reserve ratio is the percentage of a bank’s total deposit that it needs to maintain as liquid cash. In India, the CRR hike would infringe Rs 87000 crore from the banking system. It would make the banks paralyzed to reimburse and banks may increase the interest rates on loans and thus pushing the borrowing cost. It has been evident in the past as well that squeezing down the liquidity in the market of developed countries impacts the emerging markets' equity.


Talking about how the US federal bank reserve influences India as it has also tightened the liquidity in the market. Indian companies who have foot and manufacture bases in the US who had been benefiting from the ultra-monetary policy in the US now the benefit of lower-cost capital would be snatched. To tackle the inflation, the US Fed is going to sell $47.5 billion of bonds and mortgage-backed securities a month, and ramp it up to $95 billion a month by September.


In trying to take out the economy from the inflation spiral in one or another way RBI’s credibility is at the stake. In the last MPC announcement, RBI Governor Das said that the demand is not yet back to the pre-pandemic level. With the loans getting costlier, the recovery in demand is likely to face more difficulties. According to a report by BusinessLine, ‘private consumption is yet to move strongly above pre-pandemic level’. And now the Reserve bank of India is surprised by hiking the interest rate at such an instance, it can also annoy the Indian politicians. Market traders took that statement as a forecast that RBI will ignore the price pressures and would keep the borrowing cost low. Many of India’s small and medium-sized enterprises have only survived the pandemic with the help of government-guaranteed emergency loans. Now that RBI has stopped being in denial about the country’s price trajectory, the more vulnerable producers and consumers will expect it not to stop prematurely.


Authored by Priyalaxmi Roy