RBI’s Response To India’s Inflation Problems in 2021 (Revealed)

It’s been more than a year and a half since the COVID-19 pandemic struck at the heart of human society, reminding us of mother nature’s might. We thought we had regained control of the situation in India after the first wave, but the second wave left us in need of basic essentials like oxygen and medical supplies. However, in this situation, and following the continual waves of the virus, the Reserve Bank of India handled it admirably.

However, the central bank has a prioritisation challenge, as excess liquidity may be the cause of rising inflation, which is already out of its control. Higher yields are required by rising inflationary pressures, which the RBI is unwilling to provide.

The current inflationary situation is not due to excessive demand. India’s situation is hazardous since it is lagging behind other advanced countries and China on the post-pandemic recovery curve, which is driving up global commodity prices.

In June 2021, India’s primary inflation measure, the Consumer Price Index (CPI), increased by 6.26 %. CPI has now surpassed the Reserve Bank of India’s (RBI) upper tolerance limit of 6% for the second month in a row. In June, the Wholesale Price Index (WPI) increased by 12.07% , marking the third month in a row of double-digit wholesale inflation. Fuel prices, which are currently largely a tax-driven phenomenon, are at an all-time high.

The Reserve Bank, which bases its monetary policy mostly on retail inflation, has been instructed by the government to keep CPI-based inflation at 4% with a 2% margin on each side.

Monetary Policy Committee Meeting

On the 4th, 5th, and 6th of August 2021, the Monetary Policy Committee (MPC) announced the bi-monthly monetary policy review. The MPC unanimously decided to keep the policy repo rate at 4% unchanged, based on an assessment of developing local and global macroeconomic and financial circumstances and the outlook.

The MPC also decided by a 5 to 1 majority to keep the accommodative stance in place for as long as it is needed to revive and sustain growth on a long-term basis, as well as to continue to mitigate the impact of COVID-19 on the economy, all while ensuring that inflation stays within the target going forward. The bank rate and the marginal standing facility (MSF) rate both continue at 4.25 percent. At 3.35 percent, the reverse repo rate is also constant.

  • The MPC has chosen to preserve the status quo, which means that the benchmark repurchase (repo) rate will remain at 4%.
  • Actions aimed at prioritising economic growth and alleviating economic misery.
  • More needs to be done to restore the economy’s supply-demand balance; inflationary pressure is only temporary: Shaktikanta Das, Governor of the Reserve Bank of India
  • With the fading of the second wave, economic activity is normalising; consumption, investment, and foreign demand are on the mend: RBI Governor RBI maintains its GDP growth forecast of 9.5 percent in FY22.
  • Inflation is expected to be 5.7 percent in 2020-21, then 5.1 percent in April-June 2022.
  • We are in the midst of a unique scenario resulting from the pandemic, which necessitates policy assistance from all sides in order to foster recovery.

RBI’s stand on the issue

The RBI announces (or reiterates) its position in every policy. The stance clarifies what the RBI is attempting to do for everyone in the economy. A transparent and predictable monetary policy is most effective.
Governor Shaktikanta Das has stated that the critical issue is growth and that inflation, while persistent, is simply a “temporary hump.”

1- Inflation

This is the primary responsibility of the RBI. But as per the meeting and already mentioned above, this time the goal of RBI was to focus more on the growth side.

While higher inflation expectations rule out a rate drop (in order to enhance growth), they do have other major policy implications.

Q1 FY22Q2 FY22Q3 FY22Q4 FY22FY22FY23
GDP Growth21.47.36.36.19.517.2
Change from June ’21 Outlook (%)2.9-0.6-0.9-0.50
CPI Inflation5.95.35.85.75.1 (Q1)
Change from June ’21 Outlook (%)0.50.60.50.6
RBI’s Outlook August ’21 – Indian Express Report (August 2021)

One of the most concerning aspects of India’s high inflation (the rate at which prices grow) this year is that the current price surge follows high inflation last year. In addition, according to the statistics, the RBI anticipates a 5.1 percent increase in prices in the first quarter of the following fiscal year. Worse, this price increase comes at a time when overall demand in the economy is still weak; as and when demand improves, inflation will certainly soar even higher.

Two, with each month that inflation remains high, fewer people believe the RBI’s claim that this period of high inflation is merely a transient (or “transitory”) occurrence. This isn’t merely a matter of scholarly wrangling, to be sure. If the majority of Indians believe that the current bout of inflation is not temporary, their predictions for future inflation will “harden.” In other words, they are certain that inflation will continue to rise in the future. As a result, their behaviour is likely to shift.

For example, if consumers foresee more inflation next year, it will likely alter the wages they demand. This demand, in turn, will influence the pricing decisions of businesses that employ people, as businesses seek to pass along the expense of increased salaries to consumers. However, doing so will just boost the price level. It is crucial for any central bank to “anchor” inflation expectations for this reason. And the best way to achieve that is to prevent inflation from rising too quickly.

2. Growth

On the surface, the RBI’s latest prediction for GDP growth in the current fiscal year — 9.5 percent — appears to be the same as it was in June’s policy review. The RBI has lowered its GDP growth forecasts for the final three quarters of 2021-22.

If India’s economy had recovered more quickly, the RBI could have focused only on lowering inflation. However, as these changes reflect, the RBI still views the recovery as anaemic, and it believes that hiking interest rates now (to combat inflation) may harm the fragile economic recovery.

Since the beginning of the pandemic, the MPC has placed a high priority on reviving growth in order to lessen the pandemic’s impact. The available statistics indicate that the inflation process is driven by exogenous and generally transient supply shocks, confirming the MPC’s decision to investigate it. Given the economy’s slack, supply-side factors may be transient while demand-pull pressures stay inactive. A premature monetary policy response at this stage might kill the fledgling and hesitant recovery that is attempting to establish itself in extraordinarily tough conditions.

Shaktikanta Das, RBI Governor

RBI’s Stance and Policy

The RBI’s stance remained unchanged, similar to the pronouncement on GDP growth. The Reserve Bank of India has maintained its “accommodative” stance. To put it another way, it will continue to do “whatever it takes” to help the economy develop.

However, a critical modification was discovered in the fine print. Unlike in the past, when all six members of the MPC agreed unanimously on a decision, this time there was one dissenting voice.

The RBI’s mounting dilemma — between limiting inflation and boosting economic growth — is highlighted by the lack of consensus.

Regardless of how weak the recovery is, if inflation remains high, further differences of opinion among MPC members are likely to develop.

The RBI’s move to use the reverse repo window to suck out some liquidity is another indicator of the rising inflation threat. In general, a higher reverse repo rate encourages banks to deposit more cash with the RBI, lowering market liquidity.

In conclusion, The economy is still recovering and exhibiting signs of resurgence similar to those seen after the first wave last year. This is further evidenced by the RBI’s decision to keep the GDP growth objective. The RBI’s lenient stance and stable lending rates signal that growth-supporting measures would be maintained, which may help the economy stay the course and thus borrowers benefit from the continuation of the low-interest rate system.

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Bhakti Khara
I'm an undergraduate law student who aspires to be the best in my profession. As the daughter of Gujarati businessman, the world of numbers and finance has always piqued my interest. Nonetheless, I learn by knowing, doing and I also learn from the challenges and unrehearsed tasks. As an upcoming corporate lawyer, I believe it would be my responsibility to make you aware about not only the legalities associated with finance but also provide you with a wealth of information about the world of finance, which will fascinate you, as it did me.
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