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RBI’s calibrated approach to target inflation

01 Oct , 2022   By : Monika Singh

RBI’s calibrated approach to target inflation

In line with expectations, the Reserve Bank of India (RBI), in its monetary policy today, raised the repo rate by 50 basis points to 5.9%, following the foot-steps of global counterparts. Volatility in global currencies and rise in inflation rates across the world, owing to the geopolitical crisis, has made central banks cautious across the world. The RBI recognises that the domestic economy is battling volatile flows and the rupee and cannot be completely unscathed from global pressures. Thus, while they have increased repo rate, they continue with a stance of “withdrawal of accommodation” (and not neutral), while supporting growth.

The global economic activity is weakening under the impact of aggressive rate hike by the US Fed and supply chain issues on account of geopolitical tension. The US dollar has thus strengthened to a 20-year high. Emerging markets are facing intensified pressures from reallocation of portfolio flows, currency depreciations, and financial stability risks, besides inflation.

In India, however, domestic growth has been strong. The real gross domestic product grew by 13.5% in Q1FY23 on a y-o-y basis. Aggregate supply conditions are getting better. Urban consumption is being lifted by discretionary spending ahead of the festive season, and rural demand is gradually improving, thanks to a normal monsoon.

Investment demand is also gaining traction. The agriculture sector has seen a marked improvement due to a good monsoon.

Despite pressures, depreciation in the rupee has been more orderly at about 7% versus 14% in the other currencies of the emerging as well as global markets. While overall exports have come down, the services export has seen robust growth, both in IT as well as remittances. Capital goods import has been reasonably high and buoyant, and even credit flow as well as credit growth has been good.

Inflation, however, is still above the comfort level and rose to 7% y-o-y in August 2022, led by food inflation from 6.7%. Inflation is projected at 6.7% in 2022-23, with Q2 at 7.1%; Q3 at 6.5%; and Q4 at 5.8%.

Liquidity in the banking system has been tight and the RBI believes that government spending in the second half of the year is likely to provide more liquidity. The domestic economic activity is resilient. Demand is likely to peak during the festive season.

The RBI is likely to step in to support liquidity whenever needed.

Taking all these factors into consideration, the RBI has projected real GDP growth for 2022-23 at 7%.

Important takeaways

The RBI anticipates inflation to continue to be above the upper tolerance level of 6% through the first three quarters of 2022-23, with core inflation remaining high. Considerable uncertainty, given the volatile geopolitical situation, global financial market volatility and supply disruptions, has made inflation targeting all the more important.

The domestic economy, however, is holding up well and is expected to be buoyant in H2FY23, supported by consumer and business optimism in the ongoing festive season. The RBI realises that a calibrated monetary policy action is the need of the hour to control inflation and restrain the broadening of price pressures.

Thus, the RBI will continue to watch out for emerging data on inflation and growth. The goal of the RBI is to maintain price stability, financial stability and support growth as and when required. The terminal repo rate is likely to be in the range of 6-6.5% and inflation trajectory will be watched closely for further action.

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