The recent deliberations and statements of the Monetary Policy Committee (MPC) of the Reserve Bank of India (RBI) may come as a shock to the borrowers expecting an early cut in interest rates in the country. A key member of the MPC has given a clear warning that if the retail inflation in the country remains above the target or the prices boil again due to food inflation, then the central bank will not shy away from the tough step of increasing the policy repo rate to control inflation. After this statement, there is a strong signal in the financial markets that along with supporting the economic growth, keeping the inflation stable at the target of 4 percent remains the top priority for the RBI.
Central Bank will take strict stance if inflation deviates from the target of 4%
The main legal mandate of the RBI is to maintain Consumer Price Index (CPI) based inflation within the tolerance band of 4 percent (+/- 2%). According to the MPC member, even if headline inflation looks stable around 5 per cent for some time, there is no scope for policy relaxation until it comes close to the 4 per cent target on a sustainable basis. If inflationary pressure increases due to weather events, geopolitical crisis or surge in global crude oil prices, the central bank may adopt a tough stance of increasing rates by changing its 'Withdrawal of Accommodation' or neutral policy.
Food inflation and uncertain monsoon become the biggest risks.
The biggest contributor to retail inflation in the Indian economy is the food basket, which accounts for about 45 percent of the CPI index:
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Fluctuations in vegetables, pulses and spices: Due to climate change and unseasonal rains or extreme heat, frequent surges in prices of pulses, edible oils and vegetables also start affecting core inflation.
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Supply Chain and Global Disruptions: Due to ongoing geopolitical tensions in West Asia and the Red Sea, rising sea freight rates and cost of imported raw materials are increasing costs in the manufacturing sector, the burden of which ultimately falls on consumers.
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Crude Oil Prices: The sudden rise in crude oil prices in the international market directly increases inflationary pressures by increasing India's import bill and transportation costs.
Direct impact on loan EMI and general public's pocket
If the central bank decides to increase the repo rate in the upcoming policy meetings, it will have a direct impact on the budget of the general public, home buyers and the middle class:
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Increase in EMI of home and auto loan: Commercial banks (like SBI, HDFC, ICICI etc.) link their loan interest rates directly to the External Benchmark Lending Rate (EBLR/RLLR) of RBI. As soon as the repo rate increases, the monthly installment (EMI) or loan tenure of all floating rate home loans, car loans and personal loans will increase immediately.
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New borrowing will be expensive: The cost of raising working capital or new investment from banks will increase for companies and corporates, which may slow down the pace of new projects and employment creation.
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Benefits available on bank FD: The only positive aspect of rising interest rates comes to depositors and senior citizens, as banks increase interest rates on fixed deposits (FD) and savings accounts.
Outlook of upcoming MPC meetings and analysts' opinion
Economic analysts and brokerage houses believe that RBI will not show any policy relaxation in a hurry. Until clear data on US Federal Reserve policies and domestic agricultural production comes out, the central bank will remain in a 'wait and watch' mode. Only if the inflation figures go beyond the prescribed limits in the coming months, there will be a real possibility of increasing the rates, otherwise the strategy of keeping the rates at a high level (Higher for Longer) will continue for a long time.