Eye on Inflation, Focus on Growth or Both.

Recently, the Reserve Bank of India (RBI) decided to keep the policy rate (the rate at which the RBI lends to commercial banks) unchanged at 6.5% for the 9th time in a row (last increased by 50 basis points in February 2023) in its Bi-Monthly Monetary Policy.

?Let us understand some topics before moving on to the news…

?As the central bank of India, the RBI has twin goals - Price stability and Growth.

Maintaining price stability (Inflation)?- Inflation, in simple terms, is a price rise which you and I face in daily life. By law, the RBI is required to keep inflation at 4% with a leeway of 2% on both sides. The RBI considers the Consumer Price Index (CPI) for the inflation rate, which is published by the Central Statistics Office (CSO)?on a monthly basis. By maneuvering the policy rate, central banks across the world guide inflation in their economy.?

How? Let us understand...

Example - Suppose a country is facing a problem of inflation, and the smart central bank decides to increase the policy rate. It prompts commercial banks to increase the interest rates on loans, which will result in fewer demands for loans in the country, leading to reduced demand. Fewer people will demand products and services. This helps cool down inflation and stabilize the economy. It makes money dearer to people to prevent unwanted expenditure. That’s why it's also known as the "Dear Money Policy". So, the next time your bank calls you for high EMIs, it's not your bank behind it; it's the RBI that has increased policy rates.

But this has one major problem. Guess what?

Growth - Keeping the policy rate high for long affects the nation's growth negatively.

?For example - By paying more in interest, people will have less to spend on other things. If people demand less, companies will produce less, leading to less employment. Because of less employment, again, people will demand less. This keeps going and forms a cycle.

So, it is a thin rope on which the RBI has to walk to maintain inflation and growth at the same time.

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Now, the inflation number for the month of April was 4.8%, which is almost on par with the requirement (considering the 2% leeway). But according to the RBI governor, there are upside risks, particularly from food inflation due to hot summers and low reservoir levels, which could derail the path of disinflation (decrease in the rate of inflation). So the RBI wants to remain vigilant to any upside risks. The good thing is the RBI has projected CPI (inflation rate) to be 3.8% in Q2 of this financial year.

?On the growth front, India’s economy grew by 8.2% in FY 2023-24 compared with major economies: China at 5.2%, Indonesia at 5.1%, and Mexico at 3.2%. In the most recent quarter, Q4, the Indian economy grew by 7.8%.

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So, does this mean that increasing rates aren't significantly hampering India’s economic growth?

Obviously, currently, India is performing better than its peers. It looks like most things are going in India's favor, such as a stable government, low oil prices, recession in China, advancement in the IT industry, a robust financial system, a huge youth population, etc. But we have to check how world economies have performed when conditions were suitable for them. China’s economy grew for 22 years with double-digit rates since 1960 (majorly in 1990-2010), even touching 15-16% in some years, while India only achieved this three times (in 1986, 2006, 2010). So, when the situation was favorable, China realized its potential. Now, it’s time for India to try to make a big jump in favorable circumstances.

?The RBI has a tough job of balancing stable prices and boosting growth. Looking at how countries like China grew, India needs smart decisions. By taking advantage of our strengths and making wise moves, we can keep growing steadily.