RBI keeps inflation projection for FY23 unchanged at 6.7% on upside risks to food prices

The Reserve Bank of India (RBI) on September 30 announced that the inflation projection for FY23 remains unchanged at 6.7 per cent mostly due to upside risks to food prices. Earlier, RBI Governor Shaktikanta Das announced a 50 basis points (bps) increase in repo rate to 5.90 per cent on Friday, amid rising concerns over surging inflation, global headwinds and a slump in rupee to its record lows. He highlighted that the rate-setting panel is concerned about the inflation and said the central bank is watching the price situation closely.

RBI Governor Shaktikanta Das said that Indian economy remains resilient despite global headwinds wherein global recession fears are mounting, inflation high.

But he added that the inflation is expected to be elevated above the central bank’s 6 per cent threshold in the fiscal second half.
He added that fuel inflation moderated with reduction in kerosene (PDS) prices, though it remained in double digits. Core CPI, minus the food and fuel, inflation remained sticky at heightened levels, with upside pressures across various constituent goods and services.

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The inflation in India has been high since the beginning of this year. The retail inflation in India has stayed above 6 per cent since January. In April, May, June, and August, it was above 7 per cent. The RBI’s tolerance limit lies between 2 and 6 per cent.

Das said that inflation expected to reduce to 5 per cent by April-June or the first quarter of next fiscal. If high inflation is allowed to linger, it could lead to second round effects, he added.  

Correlation of repo rate and inflation

As per the norms, the central bank hikes the repo rate when the country is reeling under high inflation. It is slashed if the country is headed towards deflation. When the repo rate is raised, the interest rates paid by the commercial banks on loans from the RBI also go up. Therefore, the loans become dearer, which decreases their loan-taking capacity.

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Now, after the repo rate goes up, commercial banks, both public and private, increase the interest rates on deposit accounts for customers to increase the cash at the bank's disposal. This helps customers to earn interest on their investment, therefore, reducing the amount of money in their hands. In other terms, the high fixed deposit rates reduce the money in circulation or liquidity as investors want to earn money from savings. Thus, the demand goes down. As more and more investment is done, the prices cool down.

On the other hand, the banks also increase the interest rates on loans customers take in the form of home loan, auto loan, personal loan, etc. High repo rate makes loans costlier for consumers.

In the long run, customers would start taking fewer loans, reducing the money at their disposal. Again, this would reduce buying of items such as house, car, and others. When there is a fall in liquidity, there is a fall in demand in the economy, which ultimately brings down the inflation.