Editorial

Focus on inflation — on RBI interest rate

The Reserve Bank of India pulled a surprise on the markets on Friday by keeping its benchmark interest rate unchanged at 6.5%. The decision to stand pat comes even as the central bank changed its policy stance from “neutral” to “calibrated tightening”, indicating that rates could either go up or stay steady in the coming months. The consensus on the street was that the RBI would raise rates by at least 25 basis points to support the rupee, with some even predicting a hike of 50 basis points. Not surprisingly, the rupee weakened past the 74-mark to the U.S. dollar for the first time ever after the news of the RBI holding rates steady hit the markets. Stocks, which have been on a downtrend since September, also took a hit on Friday while bond yields fell. What is obvious is that, through its surprise decision, the RBI has chosen to stick to its primary mandate of keeping domestic inflation just around 4%, notwithstanding other risks facing the economy. Notably, the Monetary Policy Committee’s decision to keep rates steady was strongly endorsed by its members, with just a lone member voting against the decision. And its dedication to strict inflation-targeting was further reiterated during the press conference after the review meeting where RBI officials termed inflation control as their legal mandate.

With its strict focus on inflation, the challenge now will be whether the RBI can simultaneously manage the various other risks to financial stability. For now, the RBI seems to prefer piecemeal measures, such as easing foreign investment norms and mild intervention in the forex market, to address the financial risks posed by the weakening rupee. To be fair, the decision to keep rates unchanged, particularly after two consecutive increases since June, can be perceived as a strategy to keep the powder dry just in case external risks get out of hand. In this sense, the RBI’s decision could be termed prudent. The decision to keep rates steady might also work in favour of the government, which will prefer to borrow at cheaper rates in the run-up to the general elections next year. Bond yields have been on a steady rise since last year as investors have been spooked by fears over the fiscal deficit and the shift in global interest rates. The RBI’s decision to not raise rates may lift the sentiments of consumers and businesses at a time when the economy enters the busy season and festival demand kicks in. Going forward, the biggest challenge facing the RBI will be the prospect of further rate hikes by the U.S. Federal Reserve and central banks in other developed economies, which could force the central bank to look beyond its inflation mandate. The RBI will clearly have to juggle multiple challenges in the coming months.

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Printable version | May 12, 2021 1:09:16 AM | https://www.thehindu.com/opinion/editorial/focus-on-inflation/article25138042.ece

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