On May 4, the Reserve Bank of India (RBI) decided to raise the benchmark interest rate by 0.4 percentage points to 4.4%. Over the past few months, there has been a growing clamour to raise rates, mixed with anxiety over retail inflation exceeding the central bank’s tolerance limit of 6% for three months running. The surprise to the markets was in the timing of RBI’s move, via an off-cycle meeting of the Monetary Policy Committee (MPC). In a discussion moderated by K. Bharat Kumar, Shubhada Rao and U.R. Bhat discuss whether the RBI delayed the rate hike. Edited excerpts:
Should the RBI have acted on interest rates much earlier instead of waiting till retail inflation breached 6%? After all, its mandate is to target 4% inflation. Only the tolerance limit is plus or minus 2%.
Shubhada Rao: It is important to understand the context in which most central banks have behaved the way they have these past two years. It’s been a tightrope walk between growth and inflation. We have been going through an ‘abnormal’ period that started with the onset of COVID-19, followed by the Russia-Ukraine conflict. Since March 2020, central banks globally did everything they could to support growth. As central bank balance sheets expanded, interest rates dropped with a view to support growth via financial conditions that were made ultra-easy. However, the concomitant side effect of COVID-19 was also the supply shocks across the globe, which started to feed inflationary pressures. Commodity prices began rising, causing overall pressure on input costs. But at the same time, growth had been faltering. So, naturally, policymakers were leaning more towards supporting growth. However, at some point, inflation began to bite.
