The Reserve Bank of India decision to maintain status quo on interest rates, keeping the repo rate unchanged at 6.5 per cent for the seventh consecutive time, has sparked debates around its policy stance.

The central bank’s position of calibrated caution is a pragmatic response to the myriad challenges confronting the Indian economy, both on the domestic and external fronts.

Firstly, let us consider the inflation dynamics. Despite the headline consumer price index (CPI) inflation moderating to 5.09 per cent in February 2024, the trajectory remains precarious. The average consumer price inflation, projected at 4.5 per cent for 2024-25, above the central bank’s 4 per cent medium-term target.

Food inflation, which has a weighted contribution of nearly 40 per cent in the CPI basket, continues to be elevated at 8.7 per cent, driven by rising prices of cereals, vegetables, and protein sources like meat and fish, posing a considerable risk of broader price pressures and the de-anchoring of inflationary expectations.

Monsoon factor

Secondly, what complicates the policy canvas is the uncertain outlook for food inflation, which has been the primary driver of headline inflation in recent months (see graph). The RBI has rightly highlighted that the inflation trajectory will critically depend on the monsoon season this year. A normal or above-normal monsoon could open up room for monetary easing in the second half of the fiscal year.

Moreover, though core inflation, which excludes volatile food and fuel components, touched a series low at 3.34 per cent in February 2024, it has averaged 4.43 per cent over the past 11 months. This core stickiness reflects underlying demand-side pressures that could impede disinflation if left unchecked. Given India’s robust GDP growth forecast of 7 per cent for 2024-25, sustaining positive real interest rates is a prudent measure to anchor demand-pull inflationary forces.

Thirdly, the global economic landscape remains uncertain, with the trajectory of the US Federal Reserve’s policy normalisation process still evolving. As noted by various analysts, the RBI’s policy stance has been somewhat pegged to the Fed’s actions over the past two years, reflecting the interconnected nature of global financial markets and India’s external sector vulnerabilities.

Cautious approach

India’s inflation trajectory is heavily influenced by global commodity prices and the strength of the US dollar. By exercising caution and not front-running the Fed’s anticipated rate cuts, the RBI is mitigating the risks of potential capital outflows and currency volatility. This cautious approach is pertinent given India’s import dependence on commodities like crude oil, where recent geopolitical tensions have fuelled price surges, posing upside risks to the inflation outlook.

Fourthly, some analysts have argued that the RBI’s stance risks “falling behind the curve”, particularly if global central banks like the Fed pivot to rate cuts sooner than anticipated. However, RBI’s recent track record demonstrates its ability to swiftly adjust its policy stance in response to changing economic conditions.

Indeed, its latest stance of “withdrawal of accommodation” appears to be an attempt to buy time and maintain flexibility. As of now, the strong US jobs data in March has tempered expectations for an immediate rate cut by the Fed.

Finally, meteorologists predict above-average temperatures across India this summer. These factors can exacerbate inflation through supply-side bottlenecks, driving up costs for businesses and consumers.

RBI’s status quo stance will likely be a bulwark against potential internal and external shocks.

The writers teach Economics at IIM, Ranchi. Views are personal

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