RBI in tight spot as interest rate differential with US narrows
European Central Bank to follow suit with its 9th consecutive rate hike, reaching levels not seen since 2001. While these actions were somewhat anticipated, they have inadvertently created a challenging situation for India's central bank.
India finds itself at a critical point as its interest rate differential with the US has notably narrowed (see Figures 1 & 2 wherein government bond yields have been used as proxies for interest rates).
This tight spot has left the Reserve Bank of India (RBI) facing a tough decision — whether to align with global peers and raise its repo rate or opt for a differing path.
On one hand, following the global trend of raising interest rates might help control inflation and fortify the Indian rupee. However, this move carries various implications for the country's economic growth.
Despite uncertainties in the global economic outlook, India has sustained strong economic momentum since the COVID-19 pandemic, achieving a robust growth rate of 7.2% in FY 2022-23. Elevating interest rates would inevitably heighten credit costs for businesses and consumers, thus potentially dampening India's growth trajectory.
However, choosing not to raise interest rates in order to support growth may have implications for India’s capital account.
