The Reserve Bank of India today announced a hike in interest rates by 25 basis points. The repo rate was hiked to 7 per cent whereas the reverse repo rate has been hiked to 6 per cent. This is the fourth such hike in the last one year. Reason: rise in the rate of inflation, which currently is a notch below 5 per cent.
I am not an expert in monetary economics but I would like to understand a few things:
Lets begin with the basic question: Why does the RBI feel the need to hike interest rates? Probably because it feels that inflation is acquiring dangerous proportions and would therefore like to anchor inflation expectations. But, a WPI at 4.9 per cent is certainly not dangerous. In fact, it is less than the last two years average (5.9 per cent), less than last five years avg (5.2 per cent), less than even the last 10 years avg (5.2 per cent), there's more...it is less than even the 34 yr avg (7.98 per cent). So what is it that the RBI is worried about?
Another problem is that the current rise in the rate of inflation is primarily driven by supply constraints and not excessive demand. That brings me to another question: When faced with supply shocks should the central government hike interest rates or take the "reduce import duties" path(?). Inflation today is driven by food articles and petroleum products. While nothing can be done about the latter, import duties on the former can certainly be reduced. Thankfully, the government has taken some measures on that front, eg. sugar, wheat..etc. Shouldn't it be doing the same wherever it can?
...to be continued.