In its December review, the Monetary Policy Committee has predictably stuck to status quo on repo rate, while being upbeat on growth, and apparently, a tad less anxious about inflation. Accordingly, it has raised its growth projection for this fiscal from 6.5 per cent in the October review to 7 per cent now, after being surprised by the Q2 growth figure (of 7.6 per cent), which overshot its estimate by 90 basis points. Despite the usual caveats on external uncertainties, this was a policy review with optimism written all over it. This optimism seems to stem from three factors: growth impulses, ebbing inflation fears and stability on the external account.

The MPC would have drawn comfort from signals that the rate hike cycle might have peaked in the advanced economies with the ebbing of inflation there. The rupee has also been less volatile than emerging economy currencies in the face of a rising dollar. This would give the MPC the confidence to focus on domestic growth-inflation dynamics. The fact that foreign inflows are healthy this fiscal, despite a rising dollar, suggests confidence in the Indian economy. Net portfolio inflows this fiscal at $24.9 billion (against net outflows in the last two years) and net FDI flows at $10.4 billion during April-October (half of the last fiscal) would have helped stabilise the currency amidst fickle exports.

On inflation, the policy is slightly dovish. The MPC has retained its October inflation forecast of 5.4 per cent for FY24, which, as the Reserve Bank of India Governor Shaktikanta Das has observed, is above the comfort level of 4 per cent. But the difference this time lies in the projection that inflation will fall to touch the magic figure of 4 per cent in Q2 of 2024-25. A rate cut before next September is perhaps off the table. As for the present, Das has said that the need for OMO sales (to mop up liquidity) “had not arisen” — a dovish signal. There has been a liquidity deficit since the ‘hawkish’ August policy review. This coincided with the July retail inflation of 7.4 per cent, now down to 4.8 per cent in October. Das has rightly observed that any intermittent vegetable price shocks can be looked through so long as they do not become generalised. Indeed, this gives rise to a larger question of whether the MPC should focus more on the core (excluding food and fuel) component of retail inflation. A repo rate that allows for a real return of 1-1.25 per cent would perhaps be ideal.

The MPC’s growth outlook is based on “durable urban demand and gradual turnaround in rural demand”, government capex and expectations of an increase in private capex. Capacity utilisation of 74 per cent and a drop in MGNREGS demand in recent months support this hypothesis from the supply and demand side, respectively. However, the MPC has not taken into account the impact of deficient rainfall on rural demand. A cautious approach to easing liquidity should be continued in the context of the election season ahead.