The Tyranny Of Transient Inflation And RBI’s Obsession With Growth  

By not going for a rate change in the April monetary policy review, the Reserve Bank of India (RBI) has once again given preference to growth over inflation. This was the 20th meeting of the Monetary Policy Committee under RBI governor Shaktikanta Das, which taken together, have so far highlighted his focussed support for growth in the country. Though the RBI has introduced a new liquidity control tool called the standing deposit facility (SDF), it has indicated that the excess liquidity introduced through low interest rates over the last two years will be withdrawn in a multi-year period of up to three years.

Traditionally, the economic growth has been the domain of the finance ministry in New Delhi, while the RBI has focussed on controlling inflation and money supply in the economy. The two roles are divided in the financial system to ensure that overzealous governments do not ignore the plight of the low and middle classes in search of high GDP numbers.

The RBI’s logic for keeping policy rates unchanged over the past few quarters is that the current inflationary trend is transient. The central bank believes that the current bout of inflation is caused by supply-chain bottlenecks and is not a result of excess demand in the economy due to unmanageable liquidity. 

Low Interest Rates In A High-Inflation Regime

In a low interest regime, like the current one in India, borrowers benefit the most, as loans for purchasing a home, car, air conditioner, foreign education or starting a new business and expansion of existing business become cheaper. The RBI brought the repo rate—the rate that affects the interest rates that commercial banks charge their customers—to the lowest level in 58 years at 4% in May 2020. The ultra low-interest rate regime had a contrasting impact on corporates and households. According to a report by the State Bank of India (SBI), household debt in ratio to GDP increased to 37.3% in 2020-21 from 32.5% in 2019-20. Around the same period, Indian corporates de-leveraged their balance sheets that were in a bad shape for over a decade.

According to a report by Business Standard, from 2020 to 2021, India Inc reduced its net debt from Rs 26.34 lakh crore to Rs 24.44 lakh crore. Remember, corporates were also handed out a tax break by finance minister Nirmala Sitharaman to the tune of Rs 1.45 lakh crore during this period. This situation explains the bull run in the stock market even though the Indian economy tanked by 7.3 per cent in the same period.

Class Impact

Inflation has different effects on different classes in the economy. Those at the bottom of the pyramid are hurt the most due to inflation, while those at the top hardly suffer in terms of monthly expenditure. Inflation’s impact on the middle class depends upon the kind of commodities that have seen a rise in prices.

A poor person in a developing country like India spends 50-60% of their income on food and housing, while the remaining is spent on other items, including travel, health and education. At a time when people have lost their income, forcing governments to support 800 million people through free foodgrain schemes, they are not in a position to benefit from a low-interest regime in the country. Instead, what can help them is a decline in inflation in their daily consumption items, like FMCG products, clothing, shoes, edible oil, milk products. etc.

The middle class, on the other hand, is comparatively better off in dealing with high inflation. But, it is not immune to the rising cost of transport, food and housing. So far, the middle class has managed to absorb the high cost of inflation by spending more from its income, but its members too will be forced to cut expenditure on discretionary items, like travel, eating out in restaurants, purchasing consumer durables, etc. Most people in this category have a home and/or car loan, and low interest rates benefit them to an extent. But, if the final cost of the product is too high, this class also defers purchasing new articles in order to safeguard against exigencies.

The rich person is the happiest in a low-interest regime, as it brings down the cost of their business loans—this is how India Inc reduced its debt during Covid-19— and allows them to make money by investing in equity markets and live a lavish lifestyle at the cost of ordinary depositors, who earn a negative rate of interest on their bank deposits. Currently, the SBI gives a 2.7% interest rate on savings, while consumer inflation is expected to be 5.7% in the current financial year. This means that retail depositors will earn a negative interest of 3% on bank deposits.

In an article, Shankar Aiyyar, author and public policy expert, explained the contours of a monetary policy that favours only borrowers. “In 2021, India’s 60- plus segment will cross 143 million — almost the population of Russia. … It is not just the ageing senior citizens who are dependent on interest income. As per the Deposit Guarantee and Insurance Corporation, India’s banks host over 2,350 million accounts with over Rs 134 lakh crore in deposits. Of these, more than 51 per cent of accounts are under Rs 5 lakh and hold over Rs 68.7 lakh crore in deposits — money parked for education, marriage, or old age. The loss in returns affects the future plans of a large segment of savers depending on interest income.”

On the other hand, rich borrowers—high net-worth individuals (HNIs) and business owners—who invest a large amount of their income in equities and other high-interest asset classes tend to benefit the most in a low-interest, high-inflation regime. India added 40 people to its list of billionnaires in 2021, despite facing one of the deadliest Covid-19 waves, which left the entire nation gasping for oxygen cylinders and hospital beds. This would not have been possible without a low-interest rate regime, where only the rich class accumulated wealth at a time when others saw their income source decline.

Increasing Rates To Manage Cost-Push Inflation

Many experts in the government are of the view that inflation triggered due to supply chain disruption can be addressed only by supply-side solutions. Any attempt to control cost-push inflation can harm the growth of the economy. But, if that were the case, central banks across the world would not be raising interest rates. The US Federal Reserve has already announced one interest hike last month, and it will undertake six more hikes in the remaining part of the year. The Bank of England has hiked interest rates three times in a row to counter the highest rate of inflation in 30 years. Australia’s central bank is also expected to hike interest rates four to five times this year in order to control inflation before it begins to pose systemic danger to the economy.

How Liquidity Control Sets Priorities Right

Money in the economy gets directed towards the production of items that are in demand. Since high inflation affects spending capacity of lower income groups, the only items that show demand are in the luxury category. This is why luxury car maker Mercedes Benz reported a 26% rise in its sales for the January-March period in 2022. A recent survey by India Sotheby's International Realty, one of the leading brokerage firms in luxury real estate, said that 45% of HNIs will look to buy luxury properties worth above Rs 5 crore over the next two years. A low interest regime assures the rich of continued money supply, whereas a high interest rate regime does the same for lower income groups by keeping inflation low, allowing them to save more without wealth erosion. The RBI’s role is to manage the liquidity in the economy to ensure that it is used in either creating more capacity and jobs by the business class, or consumption by the low and middle income groups. GDP growth and wealth creation should be left to government policies.

The fact that India would not be able to grow at 8%, as projected in the Economic Survey earlier this year, should be the concern of the government. Mr Das’ role is to ensure that rich borrowers do not buy Mercedes at the expense of poor savers’ daily consumption.