The Monetary Policy Committee (good folks responsible for setting interest rates in the country) decided to leave them as-is yesterday (at 4%) after deliberating on the matter for three days. However, the Monetary Policy Report — published on the same day almost always offers new insights on the current state of the economy. So in today’s Finshots, we will talk about all the interesting bits from the report and more.

The Story

First thing’s first. Why did the Monetary Policy Committee choose to keep the interest rate unchanged and what does it even mean?

Well, think of it this way. There’s been a renewed debate about fiddling with the interest rate thanks to one key concern — Inflation. It works like this —  When prices begin rising across the board, the RBI can intervene and adjust the interest rate upwards. This makes borrowing more difficult and people will have a hard time accessing funds. And this is where things get interesting. If they don’t have as much money to spend, it can help quell demand. When there’s less demand, there’s a possibility that prices may moderate in tow and economists (including the Reserve Bank of India) swear by this method.

However, the current bout of inflation isn’t entirely due to demand alone. Vegetable prices are rising due to crop damage. Elevated oil prices keep nudging transportation costs. Shipping prices are going through the roof, partly due to port congestion. Raw material prices aren’t easing anytime soon and even though there’s a massive rebound in demand, it’s the supply issues that are mainly responsible for inflation.

We call it cost-push inflation.

However, there is some hope on the horizon. Vegetable prices are expected to normalize soon as the winter sets in. Remember that story about tomatoes? There’s an expectation that new supplies will hit the market in December and it's possible prices may soften soon enough. Elsewhere, the government is also looking at rationalising the tax structure on fuel. That’s a fancy way of saying that they may rework the central excise and value-added tax structure after having already done some cutting this past November. Fuel may become slightly more affordable and as prices start moderating, we may see transportation costs taper as well.

So there isn’t a lot RBI could have done about these things.

Having said that, however, it’s imperative that inflation eases up over the next few months, as demand rebounds. And boy oh boy, is it rebounding in a big way or what? Farmers are buying more tractors. Urban consumers are spending money on restaurants and hotels. They are travelling more frequently and they’re opening up their wallets like they used back in the pre-pandemic days. It’s all pointing to a recovery.

Sure, some segments are doing better than others. But at the aggregate level, there’s a definite improvement. And herein lies the conundrum. The RBI wants to support this recovery. They want to make sure that people and businesses can borrow easily if they wanted to. And if those very people are willing to deploy it in a place that could guarantee growth, then it’s a win-win for everyone involved.

Bottom line — They want to keep the interest rates low. Or at the least, keep it as is.

The one thing they don’t want to do right now is to bump up the rate. However, as with any good thriller narrative, there’s uncertainty looming in the air. Let’s suppose demand outstrips supply in a massive way. And let’s also imagine that the economic recovery goes into overdrive. If this happens we may see prices rise again but only this time, it’ll be induced by too much demand. And with supply chain bottlenecks already keeping pace, inflation could really begin to hurt Indian consumers. Which is why the RBI still wants to remain accommodative, but they want to keep a close eye on inflation.

And hopefully, this simplified explanation gives you a gist of why the monetary policy committee decided to do what it did yesterday.

Until then…

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