Rising inflation is among top concerns for the Indian economy. India's annual inflation increased to 6.5% in September 2013 for the fourth month in succession. This stands way higher than the RBI's comfort zone of 5%. Retail inflation has also risen sharply and is expected to remain above 9% levels for the upcoming period.
Though nothing much has been happening from the government's side, the new RBI governor- Raghuram Rajan is making various attempts to dampen rising inflation. Mr. Rajan had increased the repo rate by 25 bps during the month of September. This was his first monetary policy after he became governor. Again during this month the governor increased the repo rate by another 25 bps.
So are increasing interest rates good for the economy?
An article in Mint states that the rise in interest rates might impact the growth in short run, however the increase in interest rates, will help in controlling the inflation and hence this will be good for the economy in the long run.
An important point is highlighted here. The household savings are much lower than desirable. The financial savings of households as a proportion of gross domestic product have declined sharply from 11.6% to 8% in the five years from 2007-08 to 2011-12. This has been largely, due to investments shifting to real estate and gold.
In our view, investment is a key to stimulate growth in the country, and the RBI has tried to improve investment sentiment by cutting interest rates in the past. But the stubbornly higher inflationary scenario continues to force RBI to adopt hawkish stance. All that an easy monetary policy would deliver is a rise in inflation and a reduction in financial savings. Given the current economic situation, the hike in interest rate is much justified, as this in turn will help the economy in long run.