RBI has raised the repo rate by 40 basis points and the cash reserve ratio (CRR) by 50 basis points to fight inflation.
- Inflation has been rising for over two years: By law, the RBI is supposed to target retail inflation at 4%. Inflation constantly above 4% since last year.
- Inflation has not been “transitory”: The reasons for high inflation have tended to change over the months due to wide range of reasons like war, crude oil prices rise, taxes on fuels etc.
- The RBI has pointed to high crude oil prices in the wake of the Ukraine war, as one of the key reasons for high inflation in India.
- High core inflation: The core inflation which is essentially the inflation rate stripped of the effect of fuel and food prices has been rising up. This is more worrisome for RBI since it cannot be altered overnight.
- Monetary policy has lags. RBI waited too long: If the RBI wanted to contain inflation in May, it should have acted in February or at least in April. Raising rates right now may not bring down the inflation rate immediately.
- Accommodative policy stance; The most interesting aspect of the rate hike today is the continuation of the accommodative policy stance.
- The hike in CRR will suck out Rs 87,000 crore from the banking system.
- Impounding bank reserves through the CRR (Rs 87,000 crore) could give some space to the central bank to conduct open market purchases of bonds from banks and thus inject concomitant liquidity sometime in the future if the need so arises.
- The CRR rate hike is thus an important tool to possibly manage G-sec yields.
- Repo Rate: It is expected to push up interest rates in the banking system. Equated Monthly instalments (EMIs) on home, vehicle and other personal and corporate loans are likely to go up.
- Deposit rates, mainly fixed term rates, are also set to rise.
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