Growth over inflation: On economic expansion over inflation control

For the first time in nearly five years, the Monetary Policy Committee (MPC) of the Reserve Bank of India (RBI) pivoted on interest rates, unanimously deciding to cut the benchmark repo rate from 6.50% to 6.25%. This move, while maintaining a neutral stance, marks a significant departure from the previous bi-monthly review, where the committee had opted for the status quo with a 4:2 vote. At the time, the MPC was contending with inflation at a 15-month high of 6.2% in October and a sluggish second-quarter GDP growth of 5.4%. Now, with inflation moderating to 5.2% in December, still above the RBI’s 4% target, and growth projections for 2024-25 slipping to a four-year low of 6.4%, the central bank appears to be prioritising economic expansion over inflation control. RBI Governor Sanjay Malhotra, in his first policy review, highlighted the challenges posed by global economic uncertainties, including stalled disinflation, diminishing prospects of rate cuts in the U.S., and a stronger dollar pressuring emerging markets and their currencies, including the rupee. These factors have complicated policy trade-offs for India, making the case for supporting growth even stronger. The MPC justified its decision to look past current inflationary concerns, citing expectations that price pressures will ease further, with inflation projected to average 4.2% in 2025-26 from 4.8% this year. This outlook hinges on assumptions of a favourable food inflation trajectory, a normal monsoon, and a bumper harvest of key vegetables such as tomato, onion, and potato, which are, historically, major contributors to price spikes. While inflation remains a concern, the panel has signalled that weak economic growth is more pressing, especially given the second-quarter slump and limited signs of recovery since then. The RBI’s post-Budget policy stance also suggests closer alignment with fiscal policy, apparently heeding the government’s call for monetary and fiscal measures to work in tandem rather than at cross-purposes. Whether the Budget’s stimulus measures, combined with the rate cut, will revive consumption, attract private investment, and boost growth remains uncertain.

Interestingly, had the MPC met a week later, it might have had additional justification for the rate cut, given expectations that inflation in January could have cooled to around 4.5%. With a new Governor at the helm and an upcoming appointment for the Deputy Governor overseeing monetary policy, the RBI could consider adjusting the MPC’s review schedule to incorporate the latest inflation data. A slight shift in the timing of its bi-monthly meetings could make monetary policy more responsive and data-driven, enhancing the committee’s ability to justify its stance with real-time economic indicators.