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Monetary Policy: Why RBI may have chosen to err on the side of caution

Between February 2023, when the central bank last whacked up rates and now, inflation and growth are going in downward and upward directions respectively, just as they should. The repo rate, or the rate at which RBI lends to banks, stands pat at 6.5%.

rbiNEW DELHI: The RBI on Friday kept rates unchanged for the seventh consecutive time, or 14 months on the trot.

The six-member Monetary Policy Committee (MPC), much like Rudyard Kipling’s six honest serving men, summoned ‘who, why, what, when, where and how,’ and decided to go with the status quo both on rates and policy stance in a 5-1 vote split.

Between February 2023, when the central bank last whacked up rates and now, inflation and growth are going in downward and upward directions respectively, just as they should. The repo rate, or the rate at which RBI lends to banks, stands pat at 6.5%.

Governor Shaktikanta Das also confirmed that the price rise elephant was on its way back to the forest and hoped it’ll likely stay put. However, he expressed discomfort due to the volatile food component, which was behaving like a bone stuck in the throat, impeding RBI’s efforts to whip inflation back into shape.

Unfortunately, the 4% target is one full year away with RBI projecting headline inflation at 4.5% in FY25. Barring Q2 when price rise is estimated at 3.8%, each of the remaining three quarters of the current financial year will likely see retail inflation hovering well above the holy 4%. This explains Das’ repeated reminders about the unfinished job on inflation and his single-minded focus on pausing for effect, however long it takes. Perhaps, Das and his team can draw courage from Mark Twain, who said, no word was ever as effective as a rightly timed pause.

Meanwhile, growth seems to be going gangbusters, and RBI projects real GDP to crack at 7% in FY25. In fact, FY24 is likely to turn in 8%, higher than the consensus estimate of 7.6%, marking three years of 7% growth. Even if critics dismiss the growth number as a mere show pony for the 2024 elections, the government believes that FY25’s potential growth indeed will be in excess of 7%, giving enough room for RBI to focus on price stability.

Even though the headline growth number is strong, private consumption is missing from the deck. While government capex is strong, private capex is not much chop. But Das believes strengthening of rural demand, improving employment conditions and informal sector activity, moderating inflationary pressures and sustained momentum in manufacturing and services sector should boost private consumption. Investment activity remains bright owing to upturn in the private capex cycle, persisting and robust government capital expenditure, healthy balance sheets of banks and corporates; rising capacity utilisation, and strengthening business optimism — all are expected to give growth a good goosing.

Regardless of the optimism, the MPC is mindful of avoiding a mistake made on impulse. A rate cut now at this juncture will amount to a premature liftoff as inflation must be progressively hauled into the 4% target. Besides, the previous 250 bps rate hikes are not yet passed on fully making transmission incomplete. Moreover, India’s strong growth gives RBI leeway to wait until advanced economies take the pedal off the monetary tightening cycle.

So analysts now expect rate cuts to commence not later than October, unless growth turns in a negative surprise out of nowhere. Though the reductions are expected to be gradual and calibrated keeping in mind the tradeoff between growth and inflation, FY25 will likely see about 50-75 bps rate reduction.

Rate cuts lower borrowing costs for consumers and businesses, potentially triggering a burst of economic activity through greater household spending and company investment. Reducing rates too soon or too much will reverse the progress made so far on inflation. But easing policy too late or too little could unduly weaken economic activity and employment.

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