Das' dilemma: Balancing inflation and growth amid GDP shock

The Monetary Policy Committee (MPC) meeting to be held later today presents a formidable challenge for Reserve Bank of India Governor Shaktikanta Das, as it grapples with the Hamletian decision of whether to cut the repo rate or not. This ‘trial by fire’ comes against a backdrop of pressing economic and institutional factors. 

The current MPC includes three newly appointed external experts. Having experienced their first review in October, they are still acclimatising to the complex dynamics of policy making.

The extended tenure of Governor Shaktikanta Das ends on December 10, and there has been no decision by the central government yet on a possible short-term extension till March 2025.

Until the dismal GDP figures for the second quarter of the financial year 2025 (July - September) were released on November 29, Governor Shaktikanta Das had remained focused on taming inflation, the MPC’s primary mandate. 

The Governor appears unmoved and unwilling to upset the balance despite pressure from central ministers Piyush Goyal and Nirmala Sitaraman, who are batting for ‘rate cuts’ by the RBI to support economic growth. Finance Minister Nirmala Sitharaman has highlighted the “very stressful” impact of high costs of borrowings.

The Governor’s priority of taming the runaway inflation is understandable, as the consumer price index (CPI) inflation surged to 6.2 per cent in October from 5.5 per cent in September, the highest in 14 months. The ‘culprits’ are the spiralling prices of ‘TOP’—tomatoes, onions, and potatoes. The food inflation in October surged to 10.8 per cent year on year, with vegetable inflation alone contributing 42 per cent .

The unexpected GDP slowdown has rattled forecasts. At 5.4 per cent —a two-year low—Q2 GDP figures fell far below the forecasts of the RBI (7 per cent), central government, economists, and analysts
who had projected the Q2 GDP growth of over 6.5 per cent.

All the more worrisome is the deceleration of growth in sectors that are the key drivers of the economy:

Manufacturing: Down to 2.2 per cent from 14.3 per cent in Q2 FY24 (7 per cent in Q1 FY25)

Mining and quarrying: The sector has slipped into negative territory at (-)0.1 per cent, which was 11.1 per cent in Q2 FY24.

Construction: Growth slowed to 7.7 per cent from 13.6 per cent in Q2 FY 2024. The sector has a multiplier effect and affects growth in other sectors as well. 

Even worse, the fourth driver of the economy, the central government’s capital expenditure (CAPEX), has decelerated both at central and state levels to 5.4 per cent in Q2 FY25 against 7.5 per cent in the previous quarter (April - June). 

While the infrastructure allocation for FY 25 stands at a record Rs 11.1 lakh crore, only Rs 4.15 lakh crore (37.3 per cent) was utilised by September, compared to 49 per cent in the same period last financial year.

Other indicators further paint a grim picture:

The Gross Value Added (GVA)—a realistic growth indicator—has been lower at 5.6 per cent in Q2 FY25.

The GST collections in November have dropped to Rs 1.82 lakh crore from Rs 1.87 lakh crore in October.

Sales of domestic passenger vehicles are down by 15% in November YoY at 3.3 lakh units as against 3.8 lakh units. 

Growth in credit card outstanding declined to 16.9% in October 2024 from a whopping 47% YoY. Vehicle loans also dropped to 11.4% from 20%. 

UPI transactions fell by 7% in November to 15.48 billion. The fall in value is by 8% at Rs 21.55 trillion.

The only bright spot is housing loans, which rose 17.8% YoY, compared to 14.3% previously.

Adding to concerns is the shrinking of the India Manufacturing Purchasing Managers’ Index (PMI) to 56.5 in November from 57.5 in October. A PMI above 50 reflects expansion in economic activity. This is due to weakened urban demand, stagnant wages, and rural distress.

Keeping the above factors of galloping inflation on the one hand and Q2 GDP plummeting to 5.4% on the other, along with global uncertainties and geopolitical headwinds (like the US President-elect Trump threatening to impose 100% tariffs on BRICS and other countries and a depreciating rupee against the dollar), the MPC’s options are limited. 

1. To maintain the status quo in the repo rate at 6.5% with a neutral stance.

2. To inject liquidity and to overcome the liquidity deficit, reduce the cash reserve ratio (CRR) by 25 bps, which is currently at 4.5%, while ensuring inflation does not spill over from non-core to core inflation.

3. To use a variable rate, open market operations (OMO) by buying government bonds to infuse liquidity in the money market, which is inflation insulated. 

By adopting these measures and leveraging the government’s infrastructure spending, the GDP will grow above 6.5 per cent for the current financial year. The Q2 GDP shocker may yet prove to be an aberration, as “one swallow does not make a summer”. 

(The writer is a former banker)