Repo rate cut amid slowdown worries

It was not unexpected that the Monetary Policy Committee (MPC) of the Reserve Bank of India (RBI) would go in for a cut in interest rate, given the growing worries about an economic slowdown. The MPC meeting last week unanimously decided to slash the benchmark repo rate from 6.5% to 6.25%, and it was for the first time in five years that the RBI cut the rate. It was also the first meeting of the MPC under its new governor, Sanjay Malhotra.

The committee voted to continue with the neutral policy stance. Growth projections for 2024-25 have slipped to 6.4%, which is a four-year low. At the same time, inflation, which had ruled at 6.2% at the last MPC meeting, eased to 5.2% in December. The decision to adopt a less restrictive policy shows that the central bank has decided to use the policy rate more to spur growth than to curb inflation.  

The governor’s statement talks of a growth-inflation trade-off without a specific mention of an inflation target of 4%. This might indicate that the central bank would try to keep inflation within a 2-6% range rather than try to achieve the 4% target. Malhotra said that the central bank would use ‘’the flexibility embedded in the inflation targeting framework’’ while responding to growth-inflation dynamics. The MPC expects inflation to fall further and to average 4.2% in 2025-26. This may be possible if the monsoon is normal and there is a good crop of foodgrains, pulses and vegetables. A fall in food prices can be expected to bring down general inflation. While these are legitimate and justifiable expectations, the RBI has decided that growth needed a push, especially in the light of the sharp slide it saw in the second quarter. The natural expectation is that the rate cut will improve the disposable income of households and spur demand and growth. 

The governor highlighted challenges such as global economic uncertainties, a strengthening dollar, and a depreciating rupee. The volatility in the forex market may also have been a reason for the rate cut. The central bank has stated that its forex market interventions are aimed at maintaining “orderliness and stability, without compromising market efficiency” and that the “exchange rate of the Indian rupee is determined by market forces.” There is an indication that the RBI may choose to let the rupee find its own level. Several assumptions have guided the RBI’s decision, and they must come true for the new policy to achieve its aims.