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HindustanTimes Thu,21 Aug 2014

10 reasons to know why RBI Guv is worried over rising inflation

Gaurav Choudhury, Hindustan Times  New Delhi, December 17, 2013
First Published: 23:06 IST(17/12/2013) | Last Updated: 10:17 IST(18/12/2013)

By 11 am today the RBI will put out its mid-quarter monetary policy review. The central bank is widely expected to raise borrowing rates to cool inflation that has reached worrisome levels. HT explains the interplay among inflation, interest rates and economic growth:


#1 How can one read the latest inflation data to learn about price trends in Indian economy?

India’s wholesale prices grew 7.52% in November, the highest in 14 months months, driven largely by high vegetable and onion prices. Vegetable prices grew 95.25% in November compared to the same month last year, while onion prices shot up by 190.34% during the month. Overall food inflation in November stood at 19.93% compared to 18.19% in October. Retail inflation, which stood at a seven-month high of 11.24% in November, also reflected similar trends.

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#2 How do high food prices hurt families?

Sharply rising food prices hit family budgets hard. The same amount of money now buys fewer goods. Clothing, medical care, education, travelling, communication, recreation, eating out and most services too have turned dearer over the past 12 months.


#3 What are the implications of high inflation in the current economic situation?

High inflation will limit the RBI’s elbow room to cut lending rates. When growth falls, it is usually expected that the central bank cut interest rates to boost demand and spending. But in the current economic situation, where the domestic currency—the rupee—has plunged more than 20% in the last four months, the RBI can ill-afford to reducing borrowing costs as more liquidity can weaken the rupee further.


#4 What does this imply for final consumers?

Your home loans could get costlier squeezing your budget further with the RBI widely expected to announce another round of interest rate hike on Wednesday to tame galloping inflation. In the last three years, home loan EMIs (equated monthly instalments) has steadily gone up. Since they cannot be curtailed, family budgets are squeezed by cutting down on regular expenses - even on items such as clothes and consumer durables. Higher prices and need to find additional money for EMIs have forced cuts on purchases of televisions and cars.

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#5 How does the RBI use interest rates to tame prices?

Central banks across the world use interest rates to manage demand for goods. A higher interest rate will stymie demand, and, subsequently, cool prices. For instances, steeper interest rates will make buying of cars and homes costlier as these are mostly bought through bank loans. The resultant fall in demand for across the economy, under normal circumstances should bring down the rate of inflation.


#6 What is the RBI's main tool for inflation management?

The RBI primarily uses the repo rate to control inflation. Repo rate is the rate at which banks borrow from RBI. A higher repo rate raises banks' borrowing costs forcing them to raise lending rates for final individual and corporate borrowers.


#7 What can we say from inflation data about muted demand for manufactured goods?

Manufactured goods’ inflation or what economists call the core inflation—non-food, non-fuel inflation—stood at above 3% in November. At a time when raw material and borrowing costs are rising, the low core inflation can largely be explained by weak demand for goods. Industrial output—a measure of production across factories –contracted 1.8% in October from 2% in September, mirroring  tepid sales of consumer goods such as cars and televisions even during the festival month. Consumer durables output shrank by 0.9% in July, mirroring deferred purchases of televisions and cars.


#8 How have these hurt companies?

The resultant fall in demand has hit companies hurting their revenues. Costly borrowings and inputs have dampened investments as firms defer capacity expansion plans, hurting job prospects. Companies have pruned wage bills to cut corners in difficult times, offering lower salary hikes that barely take care of rising prices.


#9 What does this mean for the broader economy?

Sluggish industrial growth has led to deceleration in the broader economy, resulting in slower growth. India’s gross domestic product (GDP)—the total value of all goods and services produced in the country—grew by 4.8% in July-September, marginally higher than the previous quarter’s 4.4% growth.  Slow growth can hurt government’s tax revenues that may force the government to borrow more to fund its welfare and routine activities.


#10 What’s the outlook on the price front?

A normal monsoon this year shall help temper down food prices. Inflation, at least vegetable inflation, is showing signs of bottoming out. Stubbornly high prices of onions, which have been emblematic of India’s inflation woes, along with most vegetables, had tripled in the last one year. Over the last two weeks, however, there has been a sharp fall in onion prices—from about Rs. 80 a kg to about Rs. 50 currently—hammered down by arrival of fresh supplies. Likewise, on the industrial output front, a normal monsoon and consequent pickup in rural incomes could push up consumption growth. 

Read: Pressure on Rajan to raise rates, your EMIs may go up


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