Rajat, a 30-year-old software developer working in a top IT company at Salt Lake, Sector 5 in Kolkata, cannot avoid getting into some disagreements with his father.
Rajat’s father has recently retired from a large engineering company and lives off the interest earned from his savings. With the bank interest dropping to a minimum, he finds it difficult to make ends meet.
The situation is aggravated by higher costs of medicines, regularly needed by Rajat’s parents, and Rajat’s father has become sort of a grumpy old man.
While Rajat is upbeat about the prospects of the Indian economy, his father hardly shares his enthusiasm.
While the interest income has reduced substantially for Rajat’s father, prices of essentials are going up with no respite in sight.
The new normal is here.
Days of high inflation and stagnant income are being increasingly unbearable, especially for retired citizens.
The worrying fact is that inflation is now global, depending on various aspects.
Will the situation go bad to worse?
Or will it turn around soon?
What are the policymakers doing?
Let’s understand the issues in little more detail.
Indian Economy is Resilient
Rajat is genuinely upbeat about the prospects of the Indian economy. India is one of the exceptional countries which is showing up great GDP growth numbers. Inflation and interest rate are moderate, and economic growth is expected to continue.
He is happy to enjoy a cushy job, although he needs to put in some grueling hours.
In spite of hard work, his income is quite good. Apart from splurging on fancy dresses, eating out, and traveling, he has already gone ahead and booked an apartment in South Kolkata.
Rajat regularly tells his father that today’s youngsters think of buying an apartment at least 10 years earlier than their parents.
He thinks higher affordability of properties and a low-interest regime is a blessing.
Besides, low interest rates helped him to buy his new car at a reasonable EMI.
He dreads a high-interest period, fearing that the EMIs will go up.
Inflation is Singing Economies
Inflation is rampant now and countries that never experienced a high price rise are witnessing it. Developed countries like the US, UK, and Germany are experiencing higher inflation than India. This was unthinkable earlier.
However, there is some hope in the financial circles that inflation will be transitory and not long term.
Economies are cyclical. Yet, this time the cycle is turning quite forcefully. A variety of factors are contributing to this unprecedented situation today.
What are these factors?
Will inflation remain sticky?
Is there any danger of recession or a stagnant economy?
Let’s dig deeper and understand these issues.
Is It Different This Time?
We all know one thing.
Price rise happens due to high demand and poor supply of goods and services. When there is too much money but too few goods, there is inflation.
Central banks have increased the money supply to contain the suffering of people during the pandemic while the production of goods suffered. Even the global supply chain of raw materials, intermediate goods, and finished products got disrupted when the pandemic subsided and people’s lives started to normalize.
India, for example, ran a massive food distribution program to overcome the pandemic-induced suffering of its people. In fact, this has helped to eradicate extreme poverty.
The prices of raw materials such as crude oil and gas, coal, metals, and almost all primary industrial goods have soared because of global supply chain disruption and poor production. Russia Ukraine war has further aggravated the already difficult situation.
Central bankers thought that inflation would cool off once these temporary disruptions are over and situations normalize. Although disruptions are correcting slowly, it will take more time.
But the problem of too much money in the economic system remains. This fuels inflation and therefore all central banks are taking steps to reverse it.
Inflation reduces the purchasing power of the people. Your Rs 100.00 is worth about Rs 93.00 after a year of 7% inflation.
Runaway inflation can break the economy, devalue the currency, and create unbearable hardship for people.
There is no alternative to controlling inflation and a classical way is to reduce the money supply and increase the interest rate. An increased interest rate reduces credit and money supply in the system.
How will RBI Actions Work
On Wednesday, May 4, 2022, RBI surprised everyone with strong policy action. It increased Repo Rate by 40 basis points, i.e. 0.4%, and increased Cash Reserve Ratio (CRR), by 0.5%.
What is the Repo Rate?
The Repo rate is the rate at which banks borrow from the RBI. Hiking Repo Rate increases bank interest and reduces credit demand in the economy.
The Cash Reserve Ratio (CRR) is the percentage of a bank’s total deposits that it needs to maintain as liquid cash. This is an RBI requirement, and the cash reserve is kept with the RBI. A bank does not earn interest on this liquid cash maintained with the RBI and neither can it use this for investing and lending purposes.
Enhancing the CRR requirement also sucks out some cash from the system and helps to cool off inflation.
Banks and housing finance institutions have already changed their interest rate structure. While term loan rates were raised, offering some solace to senior citizens like Rajat’s father, home loan EMIs/tenures were also raised.
Borrowers generally have an option between paying higher EMIs and increasing the tenure.
What should you do, if you have a home loan?
It is always advisable to keep the tenure unchanged and pay increased EMI. This will contain the interest outgo and benefit the borrowers.
What Should the Homebuyers Do?
The message from the RBI is unequivocal. Inflation is a clear and present danger to the economy and the low-interest regime will be slowly reversed.
Although we do not expect gigantic leaps in interest rate hikes, we must expect that they will only rise henceforth.
Homebuyers must not wait for further interest rate actions and book their chosen properties so as to lock the prices.
Additionally, the prices of properties are expected to rise substantially.
There is no time to be lost if you are planning to buy a home now.
The window of favourable opportunity — low-interest rate and benign property prices — is closing fast.
Any delay in taking a decision will be costly.