So, once again RBI has reduced something here, and increased something there. Former will makes loans costlier which will help reduce inflation, and the latter, will improve liquidity for the banks and reduce their cost of funds which will help them with growth and profitability. Beautifully irresistible!
I am a layman who is perplexed and confused with frequent monetary policy announcements by RBI and reported in headlines by electronic as well as print media. The news value of these adjustments in interest rates and other parameters of liquidity must mean that they are important tools to control inflation and/or economic growth. As an old and probably obsolete chartered accountant, I could never understand it.
The implication should be that higher repo rate will make it costlier for borrowers to borrow which should reduce their demand for products which are on heat on inflation for last 5 years, and that should reduce inflation. Seems reasonable, but what are the products facing high inflation. Mainly these products are food items like milk, meats, poultry, vegetables, pulses and so on, and who are the people creating demand for these products, the consumers. So, consumes have to be borrowing from banks to create and sustain demand for these products which has been pushing up the prices, such that now with 0.25% higher interest rates, they will be discouraged to borrow and hence, their demand for these products will be less.
The readers may kindly treat this article as a query and advise me how true is this reasoning. Isn’t RBI simply killing economic growth by discouraging loans and thereby discouraging investment in trade and industry while not affecting the inflation at all, because no consumer of food items is borrowing from banks, and if he really is, is not going to be discouraged with 0.25% higher interest rates when he is not discouraged with over 100% increase in prices (and cost) of these items in last 5 years?
Wouldn’t it hit the nerves of logic to first find out what is the cause of inflation, is it hoarding or failure of supply to keep pace with increased demand (which is an effect of higher disposal income with consumers that liberalization since 1990 has brought about).
If hoarding is the cause, shouldn’t RBI find out whether it is helped by bank loans? If so, RBI should take measures to curb such bank credits which could be done by enforcing higher margins for calculation of Drawing Power of products under high inflation successively, and eventually, complete ban on credit availability for stocks of these items until inflation has been tamed or reversed.
If inability of supply side is the cause, shouldn’t RBI take steps to encourage investment in trade and industry so that more production capacity is installed and existing one is utilised better, so that demand and supply are brought into equilibrium. This will require lower interest rates with an ultimate aim for controlling inflation.
It is high-time young readers put some thoughts into the issue, and be vocal about this clerical approach to monetary policy, even by high profile professionals who end up behaving like babus.