May 26, 2022

For the first time in four years, the RBI MPC raised the repo and reverse repo rates by 25 basis points to make them 6.25 and 6% respectively. This has been done to make borrowing costlier in the wake of rising inflation and expectations of further inflationary pressures. The met department has forecast a normal to good monsoon this year which means that there will be abundant crop. Couple this with the game of political oneupmanship being played around farmer distress that is sure to raise minimum support prices.

Both these events will put money in the pockets of the rural population and there will be huge demand for goods from them, further increasing the inflationary trend. Then, international price of crude and commodities show no sign of easing. The RBI has already identified inflationary trend in sectors such as transport and communication, clothing, household goods and services, health, recreation, education, and personal care. It has also made an upward revision of its inflation projections for both half of the current financial year.

In such a scenario, it is prudent to follow a tight money policy and raise rates. People with home and other loans might be asked to pay an increased EMI as a result, but the effect is going to be minimal especially as several banks, led by SBI, had increased their lending rates by 10 basis points just a few days back. It seems that it was done in expectation of an RBI increase and the banks may not raise their rates further.

It is wrong to believe that small rate increases lead people to put off investment. If a project is good and viable, a 25 basis point rate increase is not going to put much pressure on its finances. Entrepreneurs are going to look for finance and keep investing, irrespective of small increase in interest rates, as long as the overall outlook for the economy remains positive. The inflation-driven rate increase by the RBI will not act as a dampener for investment, especially since the economy is on the path of revival after having shaken off the effects of twin disruptions in demonetization and GST roll-out. Keeping this in mind, the RBI has raised the quantum of SLR, giving banks more leeway in lending.