Macroeconomics Assignment

On
Current Monetary and Fiscal Policy

Submitted by:
Kevin Simon (141228)
Monil Shah (141232)
Sudeepta Pradhan (141258)
Section: B

RBI maintains a constant repo rate at 8%.

As the CPI inflation slumped to a low of 5.6 there was a lot of expectation that the repo
rate would decrease, estimation was running around that the reduction would be around
25 basis points. All speculations but proved wrong as RBI announced to keep the repo
rate constant at 8%. Was this step taken by RBI justified or should it have done
otherwise? Let us analyze some points that affect the RBI repo rate
Inflation: Inflation is one major factor on which repo rate is highly dependent. The
recent slump in the inflation can be attributed to factors other than good fiscal policy
and high repo rate. The fall in the global crude prices and a decrease in the fruit and
vegetable price globally have been the major factor that resulted in decrease in CPI
inflation. The high fiscal deficit that India has is but an alarm signal that the inflation
can go up anytime again and coupled with the fact that the political situation in the
world can always take a turn which can increase oil prices thus show a sign as to why
repo rate should not be decreased currently. This justifies the RBI decision to keep repo
rate fixed.
Retail Inflation: The projections are rife that the retail inflation will hover around 7.4%
according to IMF. Retail inflation is heavily dependent on the minimum support price
and crude oil prices. The fact that retail inflation has been double digit for a decade now
mandate the need of a tight monetary policy hence a high repo rate in India.
Low expected real return: There is no truth to the sentence that low repo rate will
ensure investment as investment will take place only when the real return is more than
the real lending rate. Though the real lending rate has hovered around 3% the
investment has been less mainly pinpointing to the fact that the real return on
investment is less. Thus this shows that the focus should not be on decreasing the repo
rate but bringing about structural reforms to increase the productivity of capital.

Neutral Monetary Policy:

Today there is a need for the monetary policy of India to be tight bit in the due course it
needs to be neutral. The fact to be decided is how much should the neutral real interest
rate be. There are a lot of factors which mandate India to maintain a positive and high
neutral rate because it is an emerging country and it is growing faster than developing
countries and its marginal return on capital is high. IMF says that the neutral rate for
India should be 1.5%

Role of RBI:
The RBI should be focused on lowering the inflation to around 6% so that the repo rate
can be decreased and the neutral rate can be applied.

References
http://in.reuters.com/article/2014/12/02/india-economy-rates-idINKCN0JF38720141202
http://www.thehindu.com/sunday-anchor/crude-fall-to-oil-indianeconomy/article6668316.ece
http://www.moneycontrol.com/news/care-research/rbi-may-reverse-policy-stance-bylowering-repo-rate-care_1244708.html
http://www.livemint.com/Opinion/72hqZoKVKXXvI7q6to5rxM/The-case-for-tight-monetarypolicy.html?utm_source=copy

http://articles.economictimes.indiatimes.com/2014-01-28/news/46735140_1_repo-ratepolicy-rate-25-basis-points