HT Correspondent, Hindustan Times New Delhi, January 15, 2014
India’s wholesale inflation rate eased to a five-month low of 6.16% in December on plunging vegetable prices, providing some relief to the UPA government, which is battling to help the economy fight through a period of low growth, high prices ahead of the national elections.
The lower inflation rate will likely prompt the Reserve Bank of India (RBI) to keep interest rates on hold in its monetary policy review later this month.
A status quo on rates will likely defer the possibility of an immediate hike in home loan EMIs, providing some relief to consumers squeezed by high prices, flat salary hikes and costly mortgage financing rates.
Wholesale price index (WPI)-based inflation — India’s most-watched price guide — stood at a 14-month high of 7.52% in November mainly due to high prices of raw materials such as onions, a key ingredient in most Indian curries.
Retail inflation — a more realistic index as it captures shop-end prices — also grew at a three-month low rate of 9.87% in December from 11.16% in the previous month as fresh seasonal arrivals pushed down vegetable prices.
Equity markets rallied on expectations that lower inflation numbers will nudge RBI not to raise interest rates.
Industry leaders have been demanding for an interest rate cut stating that high borrowing costs are hurting hiring plans.
India’s inflation rate has eased from the previous months, providing relief to the Indian government, which has been struggling with low growth, unemployment and high prices in the economy. Industry leaders demand interest rate cuts because high borrowing costs are hurting economic growth.
Inflation is the persistent increase in the average price level in the economy. Monetary policy is the set of official policies governing the supply of money in a country’s economy and the level of interest rates in an economy. 1 The Reserve Bank of India (RBI) is in charge of handling monetary policy. The manipulation of the money supply influences outcomes like economic growth, inflation, and unemployment.
High interest rates in India are hurting employment; as borrowing costs increase, business’ hiring plans are lessening. This hiring issue it due to two results of high interest rates: consumer demand falling and businesses losing more money on borrowed money. India is facing disequilibrium unemployment due to cyclical downturns in the economy- high interest rates being a major factor to this downturn. As aggregate demand falls due to a decrease in consumer spending, aggregate demand for labor shifts left (as shown in diagram #1).
Industry leaders believe that one way the RBI can help with this unemployment problem is to manipulate monetary policy in order to keep the economic growth moving in the positive direction. As show in the diagram #2 below, lowering interest rates, will increase consumer consumption and investment; therefore shifting the aggregate demand curve to the right.
Increasing aggregate demand is key for the RBI to ensure that they keep moving towards economic growth. Although the dip in inflation did provide a partial relief to the UPA government, it is crucial that the RBI continues working at manipulating the money supply to influence unemployment. The downturn in India’s economy, as evident in diagram #1, results in a decrease of demand for labor. Because this is cyclical unemployment-triggered by a fall in the economy, the solution is for the RBI to manipulate the monetary policy to increase aggregate demand. As stated in the article, industry leaders believe that the RBI must go about this by cutting interest rates. This cut would increase consumption and investments, which are both key components of aggregate demand, ultimately leading to the aggregate demand curve shifting right, as shown in diagram #2.
Decreasing the interest rate is…