RBI Rate Hike And Inflation

By admin
Aug 5th, 2011
1 Comment
Post by our guest author JAM

With the current rate hike spree of the RBI as its inflation controlling stance, it’s becoming a question of existence for several banks & Financial Institutions. With the repo and reverse repo being altered 11times in the past sixteen months, the repo and reverse repo have nearly doubled. With every increase in rates by RBI, the banks are forced to increase their rates. Majority of loans being floating interest rate, the increase in rate creates a direct impact on the various facilities that the ”aam aadmi” (the common man) as an individual or the corporate avails from the banks.
Reverse Repo bps Increase (%)
Repo bps increase (%)
July 26, 2011
50 (7.00)
50 (8.00)
June 16, 2011
25 (6.50)
25 (7.50)
May 03, 2011
 50 (6.25)
50 (7.25)
March 17, 2011
25 (5.75)
25 (6.75)
January 25, 2011
25  (5.50)
25  (6.50)
November 02, 2010
25  (5.25)
25  (6.25)
September 02, 2010
50  (4.75)
25  (6.00)
August 27, 2010
50  (4.25)
25  (5.75)
August 02, 2010
25  (4.00)
25  (5.50)
April 20, 2010
25  (3.75)
25  (5.25)
March 19, 2010
25  (3.50)
25  (5.00)
The inflation is stubbornly high and while the government is facing its own difficulties, RBI has taken the task to try and tame it and the only weapon that RBI is using is to reduce the money supply by increasing rates. RBI is showing no mercy in its efforts to tame inflation. However, with every step of increasing rates, the RBI is inducing banks to increase the cost of funds for their clients. With a Bank Base Rate (BBR) in between 10.00% and 11.00% and adding a spread of 200-300 basis points, no funds are available at a price lower than 12.00% unless and until you are the “big player” of the market with rating reports from various agencies stating a rating of “A” and above in their respective versions. 
rbi interest rate
Every increase in rate by RBI leads to an increase in your home loan rate, personal loan rate or any other funding facility you availed as a person. As an aam aadmi (the common man), earning limited / fixed income, it is becoming difficult day by day to sustain. As an organization, your working capital costs based on BBR increases and so does your Term Loan costs if they are due for resets and with a constant rate rises by RBI since more than a year, hardly any such loan would be spared from a rate increase or reset or review. 
India uses the Wholesale Price Index (WPI) to calculate inflation which includes a total of 676 commodities which have been chosen and divided into three categories, all of which have a different weight in inflation. 102 of these 676 commodities belong to the category of “Primary articles” (weight 20.12%) while 19 belong to “Fuel and Power” (weight 14.91%) group. The remaining 555 items belong to the “Manufactured Product” (weight 64.97%) group. With fuel costs increasing, input cost of raw materials increasing, all the three categories are pushing the inflation up. 
Earlier higher levels of inflation were due to the increase in food commodity prices caused by insufficient rains in 2009 resulting in lower crop. However, with bumper crop in 2010 backed by good rains, the inflation on food items have moderated from as high as 19% to 8%-9%. So what is it that is not allowing the inflation to come down? Obviously the focus shifts on non-food items or core inflation as it is called. The Non-food inflation which consists of the manufactured goods and Fuel has steadily grown from 3.5% to 7.5% now. Hence the effect of the increase in input costs is finally showing in the core inflationary products too. 
With such increasing rates of interest, the cost of funds is increasing and hence the input costs. This increase in cost is in turn transferred to consumers by the way of price hike and a price hike leads to higher inflation! So what to do now? 
The time has come when the government intervenes and rise above to tackle the problem head-on. With the monetary measures being taken by RBI, the government should be looking at certain policy measures to improve supply and decrease inflation. But the options available to government viz. Export ban, lower government spending, etc. are limited and could prove a costly affair in both national & international politics. What now? A Dead End! Should we learn to live with it now? Or let it settle by itself? However, this leads to another question which is highlighted in the Quarterly Review of RBI for April 2011-June 2011, the question of over consumption which is leading to higher demand and higher investments even at higher levels of interest rates to meet higher demand? Well, with the continuous increase and the BBRs in double digit range, we may expect a lower investment. Also, with increasing rates, the spending power may be reduced and hence the demand may start cooling off resulting to reduction in prices. An impact is already seen in the reduced growth rate of consumption of Petrol & Diesel. Is this a signal of slowdown or an impact of a sharp price rise is yet to be seen?

About JAM :

Amit M Jain aka JAM is a Management Graduate from SDMIMD. JAM works in financial domain with IDBI Bank.He is a passionate blogger and writes at D Name Is JAM .

One Response to “RBI Rate Hike And Inflation”

  1. […] “The Reserve Bank of India (RBI) was established in 1935 as the Central Bank of the Country. RBI was nationalised in 1949.” “RBI was established with initial share capital worth Rs. […]

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