To be sure, forecasts for India’s gross domestic product (GDP) growth have been rolled back sharply ever since Covid-19 disruption hit the economy. At present, most experts expect the economy to contract sharply — by as much as 10 per cent — in the current financial year. There were others who expected the RBI to stay put and avoid cutting the repo rate because retail inflation — the key variable that RBI is supposed to target — had been above the RBI’s comfort zone for most of this calendar year.
Eventually, the RBI’s MPC unanimously chose to maintain the status quo on the repo rate.
What is the link between growth, inflation and interest rates?
In a fast-growing economy, incomes go up quickly and more and more people have the money to buy the existing bunch of goods. As more and more money chases the existing set of goods, prices of such goods rise. In other words, inflation (which is nothing but the rate of increase in prices) spikes.
To contain inflation, a country’s central bank typically nudges up the interest rates in the economy. By doing so, it incentivises people to spend less and save more because saving becomes more profitable as interest rates go up. As more and more people choose to save, money is sucked out of the market and inflation rate moderates.