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Macroeconomic stability (growth with price stability) is a shared goal of the government and the central bank. Both have been assigned domains of operations: fiscal policy and monetary policy. However, every fiscal policy measure affects the aggregate demand. Elected governments depend on their performance to return to power. Fiscal expenditures are funded by tax revenue, sometimes by borrowing from the central bank, which is inflationary. Central banks should have the courage to say no to fiscal abuse. Statutory independence for the bank is an important requirement for a healthy political and economic system.
Last month, the differences between the government and the Reserve Bank of India (RBI) on the interest regime (repo rate of 6.5%) adopted for fighting inflation since February 2023 were aired publicly. Speeches by Commerce and Finance Ministers and the Chief Economic Advisor (CEA) raised questions on the intent – are these signals to RBI’s Monetary Policy Committee (MPC), before its scheduled bimonthly meeting on December 4-6 for setting a new repo? Unfortunately, they came into the open as RBI Governor Shaktikanta Das’ tenure was to end just four days after the MPC meeting.
Commerce Minister Piyush Goyal said the RBI must cut interest rates, ignoring food inflation. He claimed considering food inflation to decide on cutting rates is a flawed approach and noted that the 6.5% rate is hurting consumption and investment. The GDP growth rate in the July-September quarter was only 5.4%, compared to 8.1% in the corresponding Q2 FY24. It is also a drop from 6.7% in Q1 FY25. The government’s concerns are understandable.
On November 18, Finance Minister Nirmala Sitharaman said, at State Bank of India’s 11th Annual Banking and Economics Conclave in Mumbai, that the lending rates are causing “stress to borrowers”. She wanted the rates to be made affordable. Her comments were reported in the media as indicative of “intensifying” differences between the government and the RBI.
A day later, CEA Anantha Nageshwaran said at the conclave that if tomato, onion, potato (TOP), gold, and silver are taken out, the headline CPI rate was 4.2%, noting that these items accounted for more than one-third of the 6.21% inflation rate in October.
The MPC keeps in mind the inflation target rate of 4% which was jointly agreed to by the government and the RBI in August 2016 and is valid till March 31, 2026. It is calculated as the annual percentage change in the monthly Consumer Price Index based on items of final consumption at the retail level. As November inflation data will not be available until mid-December, the repo has to be decided based on the October inflation data (6.21%). Food inflation was at its highest in October: 10.9%.
Shifting goal posts
Food inflation holds particular significance in India due to its large low-income population. The country is more sensitive to price changes in food items. Food and beverages alone constitute 46% of the total consumption goods. The CEA’s selective approach to inflation calculation is based on expediency. One cannot take out “inconvenient” items and add what is convenient – it amounts to shifting the goal-posts during a football game.
It was left to a bureaucrat to put the lid on an embarrassing debate. Ajay Seth, Secretary of the Department of Economic Affairs, said at a FICCI convention in New Delhi that despite sectoral slowdowns, there were no significant risks to the 2024-25 growth projection of 6.5%-7%. He acknowledged the role of weather-related factors in food inflation and pointed out that monetary policy falls under the RBI’s domain. The Finance Ministry’s October Monthly Economic Review is optimistic about the food situation, thanks to improved and favourable monsoon conditions, increased minimum support prices, and an adequate supply of inputs.
However, the global economic landscape is changing with the return of Donald Trump as the president of the United States. His protectionist policies and plans for the deportation of illegal immigrants could lead to a rise in US inflation through tariffs, and a rise in labour shortage. Critical imports from the US would become more expensive and hurt India’s exports. The RBI’s role is crucial in maintaining both domestic and external stability of the rupee. By keeping the repo rate unchanged, the RBI would continue to assure financial markets of India’s commitment to stability which is vital for sustaining not only domestic but also overseas investor confidence. That would contribute to stemming the outflows of foreign portfolio investment which resulted in a decrease in the foreign exchange reserves level, and halt depreciation of the rupee.
(The writer is a former Senior Economist, Asian Development Bank. He teaches at Amrita School of Business)