Inflation may have cooled in July but it will test RBI’s patience in the months to come

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Inflation may have cooled in July but it will test RBI’s patience in the months to come
RBI governor Shaktikanta DasBusiness Insider
  • The RBI governor said that prices of pulses and edible oils have moderated in July.
  • The stubborn price rise has made life tougher for most Indians, as the economy took a hit from the global pandemic.
  • The RBI has left the interest rates unchanged at 4%.
Prices of consumer products like pulses and edible oils have moderated in July, said Shaktikanta Das, the governor of the Reserve Bank of India (RBI). However, the monetary policy committee (MPC) also increased the inflation forecast for the rest of the financial year to 5.7% from its earlier estimate of 5.1%.

“The outlook for aggregate demand is improving, but the underlying conditions are still weak. Aggregate supply is also lagging below pre-pandemic levels,” Das said in his statement on Friday, August 6.

While India’s economic growth took a beating since the start of the pandemic, the stubborn price rise has made life tougher for most Indians. The RBI has a tolerance level for consumer price index (CPI), a measure of price rise in household products, at 6% and the inflation has crossed that threshold in seven out of the last 12 months.

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Inflation may have cooled in July but it will test RBI’s patience in the months to come
CPI Inflation projection by RBIBI/Flourish

However, the central bank stopped short of taking an aggressive step like increasing interest rates to battle inflation. Simply put, inflation is caused by excess money chasing fewer goods.

In theory, increasing interest rates reduces the amount of money floating in the system, and all else remaining the same, this would cap the inflation rate.

The RBI left the interest rates unchanged at 4% for the seventh credit policy review that happens every two months. As the governor explained, a pre-emptive monetary policy response at this stage may kill the nascent and hesitant recovery that is trying to secure a foothold in extremely difficult conditions.
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QuarterProjected GDP growth
April - June 202121.4%
July - September 20217.3%
October - December 20216.3%
January - March 20226.1%

While it has not increased interest rates, the RBI has found another way to mop up the excess cash in the system.

What is VRRR and how it works?

Since Jan 2021, the regulator has been sucking out about ₹2 lakh crore from the banking system every two weeks, through a mechanism called the variable rate reverse repo (VRRR) auctions. It has now decided to increase that figure substantially.
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For the fortnight ending...Amount to be taken out via VRRR
Aug 13₹2.5 lakh crore
Aug 27₹3 lakh crore
Sept 9₹3.5 lakh crore
Sept 24₹4 lakh crore

The markets in India may see this as the first step towards tightening the liquidity by the regulator. Sucking out the money in the system affects the demand for assets, including financial assets like shares and bonds.

That has led to a fall in the stock market; both the Nifty and the Sensex are down nearly a quarter of a percent after this announcement.

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