• by Stockry
• 05th May 2022

Peer Pressure Results in Repo Rate Hike

Finally, the governor of the Reserve Bank of India (RBI) announced the most awaited decision, Shaktikanta Das, Repo rate hikes by 40 bps from 4% to 4.40%. Further, Cash Reserve Ratio (CRR) was hiked by 50 bps too. The announcement was immediately before the US Fed hiked rates by 50 bps. The rate hike was done with the motive to curb inflation, but how does a rate hike work in the economy, and why do reserve banks worldwide depend upon this tool to curb inflation? Let’s dismantle this whole scenario into bits and pieces for our readers.

The Repo rate is when RBI lends money to commercial banks, and that money further enters the economy via a loan to the borrowers. So, if the RBI charges commercial banks 4% on loans, then that money is further lent to the borrowers at 4% + bank charges and spread. So, if the repo rate increases, the loan gets expensive for the end borrowers.

How does it curb inflation?

So, suppose commercial banks sanction more and more loans to borrowers at low-interest rates. In that case, more disposable income is vested in the hands of the public, which further increases the demand for goods and services, resulting in overall inflation in the market. Now, if the reserve bank wants to get inflation under control, a rate hike is one of the tools they can utilise. If the rate hike happens, then the short-medium term loan rates also increase in the market, which discourages the borrower from taking a loan and decreases the demand for goods and services, controlling inflation in the market.

But But But………….

I don't think that the rate hike will be enough to curb the inflation in the market. This time situation is a bit dizzy i.e., and Unlike past records, inflation is driven by demand-pull and cost-push inflation. All over the world, the supply chain is entirely disrupted due to the Russia-Ukraine War, affecting crude oil, edible oil, fertiliser supply, etc. The emergence of new variants during 2022 could heighten current pressures. China's Zero-COVID strategy with its tight border restrictions has created significant problems for chip shortages worldwide.

The rate hike can help curb the inflation if it's due to demand-pull inflation, but supply disruption needs to be catered or handled differently if they want to control cost-push inflation.

What do you think? Will the rate hike help curb the inflation in the market? If yes, to what extent then….

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