New Delhi: Reserve Bank of India Governor Shaktikanta Das has said that it might be “too premature” to talk about cutting interest rates, citing elevated inflation levels. Das’s remarks in an interview to CNBC-TV18 Thursday effectively ended speculation on whether the central bank would cut rates by the end of the year or not.
Economists, on the other hand, are divided on whether the RBI’s stance on interest rate cuts might be hurting economic growth in the country.
Some, including current members of the rate-setting Monetary Policy Committee (MPC) of the RBI, argue that growth is already being hurt and that real interest rates are too high. However, others feel, as the governor does, that growth is robust, inflation is too high and that the RBI should wait before cutting rates.
The MPC, in its 49th meeting last month, left the policy repo rate unchanged at 6.50 percent — rates have remained at this level for over a year — to achieve the objective of bringing inflation down to the medium-term target of 4 percent. At the time, the latest data showed India’s retail inflation rate at a higher level than this target, although it had been easing for a few months.
The repo rate is the rate at which the RBI lends money to commercial banks, and is used to control inflation.
Inflation, as measured by the Consumer Price Index, stood at 4.83 percent in April 2024, down from 4.85 per cent in March 2024, and 5.09 per cent in February. It then dropped to a 12-month low of 4.75 percent in May, though this data was released after the MPC’s 5-7 June meeting.
In June, however, inflation again rose to 5.08 percent, according to data released Friday.
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‘RBI sensible to be cautious, prioritise inflation’
Economist Pronab Sen, the current chairman of the Standing Committee on Statistics and former chief statistician of India, termed RBI’s decision to keep the repo rate unchanged as “sensible and cautious”. He said that any decision on interest rates should be taken after the Union Budget for the year is announced.
“I think the RBI is being sensible, they are being cautious. You just had an election. There’s a new government in place. Wait till the budget comes then take a call. Otherwise, there is a very large unknown. So, I think they are being sensible,” Sen said, adding that while it is not obvious that interest rates are hurting growth, they can be reduced.
Radhika Pandey, associate professor at the National Institute of Public Finance and Policy (NIPFP), told ThePrint that interest rate decisions should be guided by inflation trends over the coming months. She noted that the policy repo rate has remained unchanged since April 2023, but growth overall has remained strong.
For this year as well, she added, the economy is projected to grow at 7.2 percent.
At present, there are no indications of a growth slowdown due to elevated interest rates, Pandey said. She explained that a cut in interest rates may de-anchor inflation expectations, and that the likelihood of an inflation level of 4 percent for a sustained period remains remote.
“The decision on cutting rates should be taken, when CPI inflation has fallen to 4 percent on a durable (sustained) level,” she told ThePrint. “Given the uptick in wholesale price index inflation and the possibility of a rise in core inflation, the possibility of inflation reaching the 4 percent level on a sustained basis, still remains some distance away.”
Aditi Nayar, chief economist and head of research and outreach at rating agency ICRA, agreed that the current policy rates are not impinging upon growth.
“If the monsoon turnout and trajectory of commodity prices suggest that inflation will moderate to around 4.5 percent this year, and not increase materially over the near term, we foresee the earliest possibility of a rate cut of 25 bps (basis points) in the December 2024 policy review, kicking off a shallow rate cut cycle of 50 bps,” she said.
‘High interest rates hurting growth’
While the MPC kept the repo rate unchanged in the last MPC meeting, held between 5 and 7 June, two of the six members — Ashima Goyal and Jayanth R. Varma — had disagreed with the majority view and voted to reduce the policy repo rate by 25 bps to spur economic growth.
Varma has been arguing for a reduction in rates for a while now, having voted for a cut in the MPC’s previous meetings as well. He pointed out that he had, in April this year, expressed concern about the growth sacrifice in FY 2024-25 induced by restrictive monetary policy. He said that it now seems that the maintenance of restrictive policy for unwarrantedly long will lead to growth being sacrificed in FY 2025-26 as well.
“Professional forecasters surveyed by the RBI are projecting growth, both in 2025-26 and in 2024-25, to be lower than in 2023-24 by more than 0.75 percent, and lower than the potential growth rate (of, say, 8 percent) by more than 1 percent,” he had said, according to the minutes of the latest MPC meeting.
“This is an unacceptably high growth sacrifice, considering that headline inflation is projected to be only about 0.5 percent above target, and core inflation is extremely benign,” he argued, noting that the current real policy rate of around 2 percent (based on projected inflation) is well above the level needed to glide inflation to its target.
Real policy rates or real interest rates refer to the interest rate after having accounted for inflation.
Surjit Bhalla, former International Monetary Fund executive director, told ThePrint that he too believes that real interest rates matter and are very high.
“They are just as high as they were in FY 2018-19, when we went into a big slowdown. In 2019-20, the GDP growth rate was something like 3.7 percent. So, obviously, it hurts. They (real interest rates) are very high. What is encouraging is that for the first time, we now have two MPC members who are arguing exactly that,” he said.
Economist Ashima Goyal argued that while the stance to keep rates unchanged may be praised as caution, doing so will reduce growth rate with a lag. Voting for a 25-basis point cut to the repo rate and a change in the stance to neutral in the MPC meet, she said that even with these changes, monetary policy would remain disinflationary towards bringing inflation credibly to the target.
“At present, only small steps are required to align the repo rate with the fall in inflation, so this should not be seen as the start of a rate cut cycle. Communication should make it clear that there is no softening path and forward-guidance remains data-determined. A neutral stance is appropriate, since the rate can then move in either direction as required,” she said.
Bhalla highlighted that it is more important that the RBI become more independent in decision-making rather than following what the US central bank – the Federal Reserve — does.
He pointed out that emerging markets, for a very long time, have been influenced by what the US does. However, this has changed post Covid, and many developing countries, emerging markets like Brazil, have started taking out new policies that are not completely dependent on the Fed.
“I think the Fed is going to cut rates (later this year),” Bhalla said. “So, they (RBI) may still be following the Fed, and then cut rates. I would like them to cut rates before the Fed does. Then, we would have a sign that they are being somewhat independent and somewhat advanced in their thinking, rather than if they cut it afterwards.”
(Edited by Mannat Chugh)
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