Tightrope walk: On RBI holding rates

By not raising interest rates, RBI betrays its concerns about slowing growth

The decision of the RBI’s Monetary Policy Committee (MPC) to leave interest rates unchanged even as the central bank warned of the major risk that ‘high inflation’ poses to macroeconomic stability is a clear sign that monetary authorities find themselves caught in a cleft stick. After a relatively benign first quarter, when headline retail inflation averaged 4.63% as against the RBI’s projection of 4.6%, price gains measured by the Consumer Price Index (CPI) accelerated sharply in the last quarter with July and August seeing readings of 7.44% and 6.83%, respectively. In a tacit acknowledgment of its misjudgment of inflationary trends, the MPC last week raised its projection for average second-quarter inflation by 20 basis points, from the August forecast of 6.2% to 6.4%. And even this projection appears overly optimistic if one considers that the headline number will need to have slowed drastically to less than 5% in September for the RBI’s prognosis to be validated. For now, the MPC is hoping that the recent reduction in domestic LPG prices combined with a lowering of vegetable prices would provide some near-term respite to price pressures. Governor Shaktikanta Das underlined the RBI’s willingness to resort to Open Market Operation sales of securities to suck out excess funds from the system if it sees reason to believe that liquidity may be rising to a level where it could undermine the overall monetary policy stance.

The RBI’s unwillingness to walk the talk and raise interest rates further, even while reiterating the threat to overall economic stability from unmoored inflation expectations, reflects an unstated concern that the growth momentum still remains rather tenuous. The recent debate on the integrity of the NSO’s data on economic growth estimates, and concern that the methodology used to posit 7.8% real GDP growth in the first quarter may have given rise to an overestimation, have to be seen in tandem with economic forecasters’ increased caution over India’s GDP growth outlook for the current fiscal year. Mr. Das acknowledged the weakness in India’s goods exports and the uneven monsoon, which has also led to a drop in kharif sowing of crucial oilseeds and pulses, as key risks to the RBI’s projection for 6.5% GDP growth in FY24. With the rupee already having weakened by about 0.7% since the last policy meeting in August, the RBI also runs the risk of importing inflation and adding to the external sector vulnerabilities if it fails to raise interest rates.