Effect of hike Repo Rate*
Common man's analysis
There are two aspects in any hike of Rate.
*First, effect of the Repo hike*
-All Banks may not be able to absorb the cost of the hike. Rate hikes have been continuous. So, this will be passed on to borrowers, except in cases where an Administered interest rate prevails. (RBI's intention is also that changes has to reach the last point).
-Borrowing will be costlier. This will also result in cost-push inflation as input cost goes up for goods and services.
Borrowers will pass on increased cost of borrowing to consumers/customers. This nullifies the RBI's intention of containing inflation to some extent by suppressing demand for Goods & Services
-While business entities can pass on increased cost to consumers, worst affected will be the Salaried section. They can't pass to anybody. They suffer. This robs of some liquidity in the hands of such a section.
-Few Banks may also increase Deposit Rate. A small section may get this benefit but this benefit is knocked down by increased, cost-push inflation of goods and services talked earlier.
-Every Repo Hike and change of rate gives rise to administration issues in Banks. There is a cost, effect and disruption involved. Interest Rate changes affects EMIs and the Period. This is bank-level discomfort to administer hikes. Unlike deposits, the rate of interest on loans has to be changed even for existing ones. We must be aware that the cost-push effect will be steeper, and even loaded, with a raise at multiple points in the supply chain.
-Policy rate changes affect liquidity mechanism, if only, repeat, if only, it really affects credit expansion or contraction. If the profit margin in the business can absorb the increased cost, then policy rate hike may not serve its purpose in entirety.
Second is the intention of the hike: -It is a tool to control liquidity in the economy and thereby demand for goods. Means, if the expansion or contraction is perceptible enough, then it can affect liquidity and purchasing power.
-This may not happen exactly as desired, to the fullest extent. Demand for goods and services is not just based on liquidity, but by other considerations like culture, practices, emotions and necessity.
- Rate changes may not give the desired result on taming inflation, unless the supply side is also regulated. While monetary policy is in the hands of RBI, *supply side correction can happen only when Govt and its implementing arms* plan well in advance, for possible seasonal variations or gaps in supply. Eg food and veg; petro-products etc.
For controlling inflation, the key is supply side!
-This critical aspect of "supply side" is hardly taken care, and over-dependance on Monetary Policy for handling Inflation should not be resorted to.
*It hurts society*
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