HT Image
HT Image

Cracking RBI’s policy maze

RBI has kept rates unchanged despite pressure from the domestic industry to slash lending costs. HT's Gaurav Choudhury explains the links between interest rates, prices and growth.
Hindustan Times | By Gaurav Choudhury
UPDATED ON JUL 30, 2013 10:58 PM IST

What has the RBI announced in its quarterly monetary policy review?
Caught between rising prices and sliding growth, the RBI on Tuesday maintained a status-quo on key rates, including the cash reserve ratio (CRR) and the repo rate.

What is CRR?
CRR is the proportion of deposits banks have to park with the central bank.

What does a CRR cut aim to achieve?
A cut in CRR means banks can unlock funds for lending. According to estimates, the 0.25 percentage point cut in CRR will allow banks an additional R17,500 crore to lend.

What is repo rate?
It is the rate at which the RBI lends to banks.

How does repo rate influence interest rates that banks charge from customers?
A lower repo reduces banks’ borrowing costs goading them to cut interest rates for home, auto and corporate loans.

What prompted the RBI to maintain a status quo on policy rates?
Skyrocketing onion and vegetable prices and costlier staples such as rice and wheat pushed India’s wholesale price index (WPI)-based inflation to 4.86% in June, adding to an array of problems for the government battling to the steer the country out of a web of economic mess in an election year.

The latest spike in WPI inflation, which was at a 40-month low of 4.7% in May, has largely been driven by high food prices which grew at 9.74% in June compared to 8.25% in May. A sub-5% WPI inflation is still well within the RBI’s comfort zone, but with high retail inflation that looks good to canter well into double-digits this month, the central bank did not slash lending costs.

Moreover, the sharp slide in the rupee, which has fallen nearly 13% since May, will fan inflation further by making most imported goods such as crude oil costlier. Consumer price index(CPI)-based inflation — a more realistic index because it measures shop-end prices — grew 9.87% in June from 9.31% in the previous month, on costlier vegetables and food items.

As long as CPI inflation remains close to double-digits and the balance of payment remains risky, analysts expect the RBI to keep interest rates high. This may have dissuaded the RBI to slash interest rates to suppress prices.

What’s the latest on the price front?
Latest price data showed that retail inflation measured by the consumer price index (CPI) stood at 9.87% in June. Experts expect prices to rise further.

Why are experts saying that prices will rise further?
A depreciating rupee will make imported goods costlier. So, expect computers, imported mobile phones and gold to become costlier. It will also make crude oil imports costlier, prompt oil companies to hike petrol and diesel prices. Costlier transport fuel will knock up prices of most goods and stoke inflation. A weak domestic currency affects the current account deficit — the gap between export earnings and import payments.

What are policy rates?
The policy rate acts the guide for final lending rates that banks charge from borrowers. In tight liquidity situations the repo rate acts as the policy rate. In situations of excess liquidity, when banks park money with the RBI from their pool of lendable resources, the reverse repo rate acts the policy rate.

What has the RBI said about prices?
While the outlook for global non-oil commodity prices remains benign, international crude oil prices are firming up. This is reflected in an upward adjustment of domestic prices of petroleum products, besides the regular hikes in diesel prices. The sharp depreciation of the rupee since mid-May is expected to pass through in the months ahead to domestic fuel inflation as well as to non-food manufactured products inflation through its import content.
According to the RBI, the timing and magnitude of the remaining administered price revisions are a source of uncertainty for the inflation outlook.

What has the RBI said about growth?
The RBI has forecast that India’s GDP will grow at 5.5% in 2013-14, down from the 5.7% it had projected earlier. Industrial activity was expected to remain subdued, and growth in services and exports was expected to stay sluggish owing to global growth not improving significantly.

Story Saved