The Reserve Bank of India has yet again -- but on entirely expected lines -- raised interest rates again following its global peers in tandem as it seeks to bring high and continually rising inflation under control. The policy of raising interest rates -- the rate at which the RBI lends to banks -- has been a tried and tested formula to keep demand in check and thereby bring inflation down. However, this time it seems to be different. Since April this year, the RBI has introduced several rate hikes after years of constant reduction in interest rates that led to lower borrowing, especially for those who needed home loans but also, on the flip side -- lower rates on fixed deposits.
Over the course of a few months, home loan rates have gone up to nearly 9% from around 6.5% six months ago, but also inflation is nowhere under control. Instead, it continues to rise and has now touched 7% year on year and has shown no signs of easing off. Clearly, the RBI policy is not working as desired or rather as well as the RBI hoped. This in large part is due to the fact that inflation at present is caused -- in part -- by supply issues. High oil and gas prices are on account of the Russian war in Ukraine and subsequent sanctions that have led to supply-side issues taking oil prices through the roof -- while oil companies make a windfall over the high prices.
Similarly, a global shortage of food grains and agricultural produce caused by multiple factors including lower output caused by heat-waves and an irregular monsoon as well as a global shortage caused by Russia holding Ukrainian grain to ransom has had a knock on effect across the globe. That the Rupee has depreciated steeply against the dollar is only making inflation worse.
In such an environment it is no surprise that rate hikes have done little to bring inflation under control given that the real causes of inflation are yet to be addressed. Instead, what the rate hikes will do is hit the Indian consumer from both sides. The average bread earner will not only be paying more each time he visits the market but he will also have less to spend because his home loan (or any other loan rate for that matter) rate has gone high pushing him further into debt.
This points to a deathward spiral in which higher rates combined with inflation will cause more people to default on their loans combined with a lack of demand for even essential commodities making the possibility of a recession looming on the horizon. The cycle of rate hikes to combat inflation and rate cuts to battle recession appears to have run its course and the RBI -- as well as its global peers -- will have to think of new ways to come out of the mess we currently are in.
A swift end to the Ukraine war will immediately help but that doesn’t appear to be anywhere close to completion and could drag on for a year or more despite the recent gains the Ukrainians have made. With the onset of winter not far away, both sides will only entrench their positions further, possibly leading to an impasse or could just as quickly take a catastrophic turn should the war escalate. The RBI needs to rethink its strategy and go easy on the rate cuts and instead explore other measures to cool inflation.
