RBI hikes repo rate by 50 bps to 5.90%; home, car loans to be impacted

Context

Last week, the rupee weakened against the dollar past the 81-mark to a record low. In recent months, the depository financial institution of Asian nation (RBI) has been intervening within the FOREX market to smoothen the decline. Indian interchange reserves have fallen by regarding $94billion in twelve months to regarding $545 billion till mid-September. Falling Indian rupee poses vast challenge within the economy.

What area unit the main challenges before Indian Economy?

Falling rupee: A fall within the rupee against the dollar within the FOREX market means the Indian currency is weakening. this suggests that whereas importation from the us or any country, Asian nation can ought to pay additional as a result of the payment is completed in greenbacks, i.e., less import value additional.

Inflation: Since could this year, run batted in has mostly managed to regulate inflation. run batted in managed inflation to stay it below seven.5 % but, gazing Ukraine scenario, oil costs could increase once more and there by inflation can rise.

Growing CAD: India's accounting deficit (CAD) in April-June was at $23.9 billion, or 2.8 per cent of gross domestic product (GDP), abundant beyond the $13.4 billion, or 1.5 per cent of GDP, in January-March 2022. Asian nation has baby-faced upward pressure on its import bill in 2022 as a result of Russia's invasion of Ukraine in late Feb crystal rectifier to a pointy rise in costs of commodities across the world.

What is RBI's role in managing falling Rupee ?

Use of exchange reserve: the utilization of FOREX reserves is acceptable at this juncture. You build your reserves throughout sensible times and pay them throughout dangerous times. Right now, reserves ar being spent in making an attempt to curb currency volatility. run cannot defend the rupee at a selected level, as a result of that might be swimming against the tide, that isn't potential during this surroundings. however run will build it less volatile.

Easy dollar supply: run has already undertaken measures like easing provisions for remittances, permitting short-run foreign portfolio investments in government securities, etc. we are able to even consider a theme just like the one introduced in 2014to attract NRI investments.

Interest rate: Interest rates ar being raised not solely to regulate inflation, however conjointly to handle external imbalances. however let's conjointly investigate past episodes of sharp depreciation of the currency that we've seen throughout the global financial crisis, throughout the taper ill temper. They tell North American country that the currency weakens terribly sharply throughout these episodes of worldwide shocks, however it conjointly corrects. If you plot it over a 15-20-year amount, you'll see that the overshooting of the currency usually gets corrected once the event is over. So, the aim currently ought to solely be to confirm that volatility isn't too high, to not steer the currency in any direction.

Managing the CAD: per consultants, run will finance the CAD with capital inflows, and stop hot cash outflow with the help of interest rates, that might be a good long-run answer. the main target ought to get on however we are able to stem capital that's flighty. Even throughout the tenure of Raghuram Rajan the CAD went up to four-dimensional. but the instant hot cash became flighty, panic set in. Till then, we were well finance the CAD with capital flows.

What are the Notes of caution?

On FOREX: There is also a limit to how much you can lean on the reserves. They can burn out pretty quickly if you are aggressive in your interventions.

On rupee fall and CAD: RBI also needs to let the rupee depreciate in an orderly manner. Some, but not too much, depreciation will partly help the export sector, as global demand is the key influencer of exports, and currencies of our competitors are also weakening. So, the vulnerability that stems from high current account deficit (CAD) can get addressed to some extent.

On interest rate: We have to focus on the real interest rate and economic growth, for public debt management. If the Real interest rate is going to be greater than Growth, then we are in an unsustainable situation. The only way to address these concerns such as fiscal consolidation, twin deficit crisis, given that the real rate of interest is negative, given the hawkish mode of the Fed, is to raise rates.

Conclusion

With rising external trade, India's economy is integrating with world. Impact of global uncertainty on economy is natural outcome. Ukraine episode, slowing Europe and unclear USA is going give Indian policy maker a tough time in coming months.