MPC waits for US Fed to cut

That the Monetary Policy Committee (MPC) of the Reserve Bank of India (RBI) would not reduce policy rates on Thursday was widely known. However, the fact that it has retained its policy stance at withdrawal of accommodation suggests that the hawks within the MPC continue to hold sway. Both the policy rate and policy stance setting have seen two dissensions in the last two MPC meetings.

Are these rational decisions? There are good reasons to argue that they are. The benchmark inflation rate continues to be above RBI’s target of 4%, and it is expected to remain there until the quarter ending June 2025, the latest period for which MPC has made its forecasts. A 7.2% GDP growth forecast for 2024-25 does not call for any drastic measures to boost economic momentum. Macroeconomic stability and, more importantly, policy commitment to preserve it have become all more the important in a world plagued by geopolitical tensions and growing concerns about a slowdown if not a recession in the world’s largest economy.

But it is eminently possible to build an alternative set of arguments as well. The reason inflation is still above RBI’s target is food prices. This is largely a result of seasonal supply-side disruptions rather than excess demand in the economy and, therefore, makes higher interest rates pretty much redundant in controlling them. With seasonal shocks becoming increasingly frequent and unpredictable in food markets, it can very well be the case that food inflation will continue to frustrate inflation aligning with target on a long-term basis. Does this mean interest rates will continue to be where they are?

Nobody expects this to be the case, and most independent analysts are expecting MPC to start reducing rates from either its October or December meeting. This underlines the importance of the (tacitly unacknowledged) exogenous factor in MPC’s thinking and decisions. Until the US Federal Reserve cuts interest rates, a reduction in policy rates in India can potentially trigger capital flight or put pressure on the rupee. To be sure, this constraint on economic policy in emerging markets like India is systemic in nature and cannot be wished away in the name of asserting autonomy.

Fortunately for India, this systemic constraint has come at a time when the economy is not doing too badly. Of course, this does not undermine the larger challenge of making demand broad-based, which is essential for a sustained revival in private investment and, therefore, overall growth.

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