Another round of rate hike by RBI may threaten economic recovery, say economists

Economists expect a 50 basis points (bps) rate hike in the upcoming policy meeting of the Reserve Bank of India (RBI) with August CPI inflation rising to 7 per cent year-on-year (YoY) from 6.7 per cent YoY in July. The expected rate hikes and inflation crossing 7 per cent indicate that economic activity might remain upbeat but there will be some challenges in the economic recovery in the coming months, say economists.

“Notwithstanding the undershooting in the GDP growth relative to the MPC’s projections for Q1 FY2023, and the expectation of a slightly lower-than-projected CPI inflation print for Q2 FY2023, we now foresee a higher likelihood that the MPC will stick to the new normal rate hike of 50 bps in its September 2022 meeting, with the headline inflation having reversed to 7 per cent in August 2022," said Aditi Nayar, Chief Economist, ICRA.

Rate hike and Indian economy

Some aspects of economic activities like investment demand and borrowing cost are likely to get affected due to the rate hike in the upcoming policy meeting.

“A rate hike will result in higher borrowing cost. This high cost will impede investment demand which is at the nascent stage of recovery,” added Jahnvi Prabhakar, economist, Bank of Baroda.

Economists cautioned that RBI should ensure that hikes in interest rates should not lead to the virtual denial of credit to businesses.

India’s gross domestic product (GDP) is expected to register a growth of 7 per cent in FY23, provided the RBI and the government keep some checks and balances to ensure sustainable growth. “The government should focus on capex spending to push for speedy and sustainable growth. Besides, more supply-side measures to ease pressures emanating from food prices (especially spices) could be beneficial,” said Swati Arora, economist, HDFC Bank.

Moreover, to ensure sustained economic recovery amidst rate hikes and growing inflation, the supply side needs to be taken care of, suggests economists. Although supply has not been affected yet, it could be a contributing factor in affecting economic growth, if not taken care of.

“The best way to deal with inflation or commodity market inflation is to ensure improvement in supply. But that can't be done in the short run. So, the second best course is to check demand which RBI can do,” said Ritesh Kumar Singh, a former assistant director of the Finance Commission of India.

Ways to counter the challenges 

Economists stressed the fact that the government and the RBI have been taking measures to ensure the rate hikes and inflation affect economic growth at a minimal level, while some other initiatives can be taken to ensure sustained economic growth.

With the chances of borrowing costs going up, borrowers need to think of alternatives. “Borrowers have to look for alternate sources. This can include ECBs and the bond market,” said Prabhakar.

Moreover, the government has already announced supply-side measures to prohibit exports of wheat and rice, among others, to control price pressures. Else, the price pressure would have affected the economy in the coming quarters, added economists.