The RBI logo.
Credit: Reuters File Photo
The Monetary Policy Committee (MPC) of the Reserve Bank of India (RBI) is set to hold its bimonthly meeting on February 5-7, its first of the year. The meeting will be held against the backdrop of a depreciating rupee while it has revived, again, expectations of a policy rate cut – potentially the first since May 2020 – to boost a slowing economy.
There is pressure to reduce the current rate of 6.5%. However, ignoring the rupee’s depreciation could still prove tricky. MPC is likely to have reservations about taking a plunge into unknown depths and may prefer to wait for two more months until the next meeting, in April.
FY25 began on a distressing note, with the economic slowdown. The final quarter of FY24 (January-March) recorded a 7.8% growth in GDP as against three previous quarters of growth above 8%. In the first and second quarters of FY25, the growth rates slipped further to 6.3% and 5.4%. The government was quick to blame it on the RBI’s policy interest rate, at 6.5% effective from February 2023 as an anti-inflationary measure. While Industries Minister Piyush Goyal did not want food inflation to be taken into account in the calculation of retail inflation, Finance Minister Nirmala Sitharaman said the interest rate was causing stress to investors and consumers alike.
Since the inflation data of January 2025 will be available only on February 12, it is prudent to argue that the committee could have met later in the month, for a deeper analysis of data from two full months – December 2024 and January 2025. The inflation data from January is critical in assessing the impact of the depreciation on the trade deficit. It will also be appropriate to make a departure from the existing routine and hold all future MPC meetings in the third week of the month.
The RBI’s State of the Economy Report in January 2025 is cautiously optimistic with the words: “as domestic demand regains strength, stickiness in food inflation warrants careful monitoring.” Though rural demand continues to gain momentum, supported by brighter agricultural prospects, growth in FY25 will be at a four-year low of 6.4%.
The RBI has been reminding the nation of the criticality of food inflation as the weight assigned to food and beverages in the calculation of consumer price index (CPI)-based retail inflation is 46% and that the target rate is 4%. Food production is influenced by weather-related factors beyond human control. Inflation in October was 6.21%, with food inflation at 10.9%. The inflation came down to 5.5% in November due to favourable weather, and 5.2% in December.
A steady fall
The Economic Survey presented to the Parliament on January 31 noted that while global food inflation eased in 2024 due to improved supply conditions, three emerging market economies – Brazil, India, and China – showed contrasting patterns. The government has focused on controlling food inflation through various supply-side measures that include strengthening the buffer stock of essential food items and periodic open market releases, subsidised retail sale of essential food items in specified outlets, easing imports of essential food items through rationalisation
of duties, prevention of hoarding through imposition/revision, and monitoring of stock limits.
As early as end-September last year, foreign portfolio investors had begun pulling out their funds from short-term investments in bonds and stocks held in emerging markets and developing economies (EMDE) for investing in the US. Not only the currencies of EMDEs but also of advanced countries have dipped in value. The Indian rupee depreciated the least – 3.6% in 12 months – but the fall has been steady since October. The RBI has made interventions by selling dollars for rupees. The resultant rupee shortage has to be met with open market operations. In the process, the foreign exchange (forex) reserves have come down from the record $705 billion reserves reached in September.
The RBI is not aiming at any specific exchange rate. The daily market rate is referred to as nominal exchange rate, determined by free market forces. What is more relevant is the trade-weighted real effective exchange rate (REER) for determining export competitiveness. The REER is the rate adjusted for relative price levels of India (India CPI) and the world price index (US’ and major countries’ average CPI). An overvalued REER has been seen as hurting India’s competitiveness. Experts including former RBI Governor Raghuram Rajan are of the view that a little depreciation seems in order.
(The writer is a former Senior Economist, Asian Development Bank)