RBI is cautious, and rightly so

There are always expectations that the RBI cuts the policy rates to revive the economy. But inflation numbers have this uncanny ability to spring a surprise.

The Reserve Bank of India’s (RBI) Monetary Policy Committee (MPC) voted to keep the policy repo rate unchanged at 6.5 per cent. The decision is in line with market expectations. Even if the Indian economy is faring better than market expectations, the global economy (especially advanced economies) is not yet out of the woods.

RBI Governor Shaktikanta Das echoed this sentiment saying that history will record the period 2020-2023 as one of ‘great volatility’. The highly volatile and uncertain global events have led some experts to call this phase ‘VUCA’: Volatile, Uncertain, Complex, and Ambiguous.

The period has seen a series of black swan events coming one after the other. The Covid-18 pandemic led to largescale demand and supply shocks. It was followed by a recovery and the Russia-Ukraine war, creating global supply shocks which have led to inflation levels last seen 40-50 years ago.

High inflation has pushed central banks to increase policy rates. The high policy rates in the United States led to a regional banking crisis which spread and led to the failure of a large Swiss Bank. Both the US and the Swiss banking systems, which were once the cynosure of world banking, have been caught off guard twice in 15 years. Things did not end here, as we are seeing another conflict between Israel and Hamas, which has created concerns over oil prices and the general political environment.

These global VUCA events have weighed on economic projections. The International Monetary Fund (IMF) releases its World Economic Outlook four times in a year. The IMF has changed its projections with each release. For both the world economy and the Indian economy, the IMF has revised growth for 2023 upwards and downwards for 2024.

Given the IMF’s projections, let us review the RBI’s projections for India on the growth and inflation front.

In the April 2023 monetary policy, the RBI projected a growth of 6.5 per cent for the whole year. The growth rate in Q1 was in line with expectations, but Q2 exceeded projections by a large margin. This has led RBI to revise the growth projections to 7 per cent. The IMF will likely revise India’s growth for 2023 as well.

The RBI is an inflation-targeting central bank and accords primacy to bringing inflation within 4 per cent with a band of +/- 2 per cent. It has missed its inflation target for a few years now. For this year, the RBI initially projected an inflation of 5.2 per cent, but later changed its views. This change was driven mainly due to higher-than-expected numbers in Q2 where inflation was nearly one per cent more than the projected number in the April and June monetary policies. As a result, the RBI’s latest inflation projection given in the December policy is 5.4 per cent, which is higher than the target.

Following this spurt in inflation, the RBI has become cautious and concerned with its inflation outlook. In its monthly State of the Economy Report, the authors stress that despite the recent decline in inflation, “We are not out of the woods yet and have miles to go” in terms of inflation.

To sum up the macroeconomic outlook, both the GDP numbers and the inflation numbers have surprised on the upside in Q2 2024. Accordingly, the RBI MPC decided to keep the repo rate unchanged as there is no real need to tinker with the interest rates. There are always expectations that the RBI cuts the policy rates to revive the economy. But as inflation numbers have this uncanny ability to spring a surprise, the central bank is unlikely to act on lowering rates in the near future. The GDP numbers have so far looked good, which further rules out any hope of a decrease in interest rates.

Apart from monetary stability, Das also stressed on the need to monitor financial stability. He said we should not “wait for the house to catch fire”. The RBI has recently taken measures to address growing risks from a rise in personal loans by banks and Non-Banking Financial Companies (NBFC). Das added that in today’s times, one can get risks from anywhere and have to always be watchful and prepared to act in case of the emergence of new risks.

Amol Agrawal is an economist teaching at Ahmedabad University.

Disclaimer: The views expressed above are the author's own. They do not necessarily reflect the views of DH.