To raise or not to raise the repo: Inflation should be RBI's only concern

The Reserve Bank of India is to decide on the country's interests rates when it reviews the monetary policy Wednesday. Given the rising inflation, depreciating rupee and volatile macroeconomic situation, industry as well as the Union government would hope the central bank remains patient and let at least two more months pass before increasing rates.

A large section of experts think that the monetary policy review committee would hold the 6% repo rate – the rate at which banks borrow from the RBI to meet short-term funding requirements.

In previous reviews, the apex bank hinted at two likely increases in repo rate this year. Timing, in such a case, would be crucial.

What's at stake?

Rising fuel and food prices have added to India's inflaion. Retail inflation accelerated to 4.58% in April, after easing for three straight months. Core inflation, at a 44-month high of 5.9%, was an even bigger worry. 

If the RBI does not act, inflation may breach the 6% comfort zone, bearing down on consumption. Already, both manufacturers as well as service providers are considering marking up prices.

The dillemma

If the RBI's MPC members hold controlling inflation as their only duty then it makes sense to go for a small hike in the repo rate to kill inflationary expectations in the current policy review. But, since the Indian economy is on the cusp of recovery, waiting for a couple of more months may just be the right thing to do. 

India's gross domestic product increased at 7.7% in the fourth quarter of 2017-18. The growth currently has demand support, eg car sales are already growing at double digit rates. Loan rates at current levels would be a psychological boost for consumers to purchase on credit.

Moreover, due to rising bond yields, banks are under pressure to raise deposit as well as lending rates irrespective of the repo rate. Increasing it thus may add to the burden and push up effective rates by 50 basis points (half a percent) in the coming months, putting the economic recovery under stress.

An ideal way out

A significant cause of the inflation is high fuel prices. The increase is due to higher international crude oil prices, but the central as well as state governments' role can't be denied. Taxes on petroleum products have doubled since 2014.

Despite crude prices at as low as just $78, pump prices are at their highest ever. The Centre must take a call on whether it wants to collect taxes to push the economy by keeping government expenditure high, or it wants to take a tactical call on putting more money in the hands of people to push consumption.

Therefore, the RBI must focus on what it does best. Control inflation at the earliest. And in case the government feels strongly about keeping interest rates low, it should bite the bullet and lower oil taxes.