In a sudden move on Wednesday, the Reserve Bank of India raised the repo rate by 40 basis points as well as increased the cash reserve ratio by 50 basis points. The repo rate is the interest at which the Reserve Bank lends to banks. The CRR mandates the amount of liquid cash a bank must maintain. A basis point is one-hundredth of a percentage point.
These changes are aimed at getting banks to raise interest rates on loans as well as deposits (such as fixed deposits). These levers will incentivise Indians to save more. With less cash available to be spent, inflation or rising prices could be curtailed.
The suddenness of the move as well as the quantum of the increases came as a shock for commentators as well as the share market on Wednesday. The Sensex plunged by over 1,300 points.
The move has been driven by rising inflation
For the past two years now, inflation has been uncomfortably high. In March, retail inflation was nearly 7%. This is significantly above the Reserve Bank’s target of 4%. This could have been the final straw for the central bank, which rushed to announce these increases even though a revision of rates was expected only in June.
Part of this two-year trend could be attributed to India’s harsh lockdowns through the Covid-19 pandemic, which threw the economy out of gear. With both manufacturing plants and supply chains disrupted, fewer products reached Indian consumers, leading to their prices shooting up.
Adding to this is the Russia-Ukraine war, which has led to a significant rise in oil prices along with critical commodities such as edible oil and wheat. In April, Indonesia banned exports of palm oil – a move that would make edible oil prices in India shoot up.
The third factor includes high taxes on fuel that India levies. Fuel prices rose by 7.52% in March.
Inflation is a political hot potato in India
However, this focus on controlling inflation could hurt economic growth. This is worrying for India given the hits it has already taken during the pandemic. To add to that are worrying unemployment figures. Growth figures are now high because of the post-pandemic bounce back. When this ends, worse could follow. The Reserve Bank, for example, thinks growth during the second half of the current financial year will only be around 4%.
However, we know from recent Indian history that while Indians can stomach poor growth rates, high inflation gets them very angry. It is now believed that rising prices were one of the reasons for the spectacular unpopularity of the Manmohan Singh-led government as it went into elections in 2014, allowing Modi to capture power in Delhi.
How Modi has controlled prices till now
Narendra Modi, it would seem, has not ignored this lesson. In 2016, he ordered the Reserve Bank to do all it could to keep retail inflation limited to 4% (with a 2% tolerance band). In addition, the Modi government has been harsh on farmers in order to control the price of food. From stock limits to harsh regulations on imports and exports, the Indian government makes sure that farmers are unable to trade their produce on the free market as a way to indirectly subsidise food consumers.
However, Modi’s harsh lockdowns during the pandemic and then the unexpected Russia-Ukraine war seems to have upset this carefully stacked apple cart. The Reserve Bank’s drastic announcements on Wednesday make it clear that inflation is a major problem and it is here to stay.
Waters could get choppy for BJP on price rise
Politically, for the past two years, the Modi government has managed anger due to inflation (and unemployment) by using a combination of emotive issues revolving around Hindutva along with economic support for the poor in the form of welfare.
To this mix was added strong control over the narrative using mainstream Hindi and English media, which ensured that anger, even if it existed on the ground, was rarely allowed to be aired – the first step to the problem becoming political.
This play has been fairly successful, as the massive Uttar Pradesh win earlier this year showed. But even the Bharatiya Janata Party’s masterful grip over political strategy would face significant strain if Indians face falling incomes due to unemployment as well as falling purchasing power due to inflation for too long.