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Informist, Wednesday, Nov. 6, 2024

 

By Siddharth Upasani

 

NEW DELHI – Exactly a month from now, the Reserve Bank of India's Monetary Policy Committee will announce its next interest rate decision. After the stance of policy was shifted to neutral from withdrawal of accommodation on Oct. 9, it was natural for the market to expect the first rate cut in four and a half years from the committee on Dec. 6. Instead, the central bank has looked to talk back these expectations in light of headline retail inflation jumping to a nine-month high of 5.49% in September from 3.65% in August.

 

CPI inflation was expected to rise sharply in September and remain there in October due to an unfavourable base effect and the RBI had said as much on Oct. 9. This was built into the central bank's forecast, with inflation seen averaging 4.8% in Oct-Dec, up from 4.1% in Jul-Sept. To be sure, the September print was around 40 basis points higher than expected, resulting in the average for the second quarter of 2024-25 (Apr-Mar) exceeding the RBI's projection by 10 bps--hardly a meaningful number.

 

But if monetary policy is supposed to be forward-looking, why has Governor Das spoken out so strongly against a repo rate cut? As is well known, changes to interest rates impact inflation with a lag of three-four quarters; a paper co-authored by Deputy Governor Michael Patra said last month that the 250 bps of interest rate hikes since May 2022 had reduced inflation by 160 bps over the next two years or so.

 

This is why the one-year-ahead inflation forecast is so crucial for the RBI. In his statement in the minutes of the Oct. 7-9 meeting, Patra said his "metric of four quarters ahead inflation" showed "inflation is reconfiguring towards the target", although it would "encounter a hump" in the short term--again, as shown in the projections--due to a low base and one-off food price shocks that monetary policy could "look through".

 

This is not to say that the MPC should not be cautious or should boldly approach the rate easing cycle; risks must be monitored, especially with the monthly inflation number having been at or below the medium-term target of 4% on only two occasions in the last five years. But the central bank's own forecast shows inflation falling to 3.7% in Jul-Sept 2025 and averaging 4.1% in FY26 as a whole. If realised, this would be the lowest inflation has been since FY19.

 

Like wizards, central banks like to think they are never late, or behind the curve, and that they act when the time is right. The problem is that multiple members of the MPC, over the last half a year or so, have felt the time is right to lower interest rates. It first started with Jayanth Varma, who voted for a rate cut in February as well as in April. He was joined by fellow external member Ashima Goyal in June and August. In October, it was Nagesh Kumar who was the sole member of the reconstituted MPC in favour of lower interest rates, pointing out that several central banks around the world had already started doing so. Varma, Goyal, and Kumar may have been in the minority each time, but the fact that three rate-setters want the repo rate to be lowered should not be ignored.

 

Interest rate decisions are subjective and differences in opinion are to be expected. However, the explanation for the decisions must be sound. Warning against a rate cut in December because of two elevated inflation prints in September and October, which were due to a low base and one-off food price shocks, is not convincing. What matters is how much prices are expected to rise a year down the line, not in the next two months.  End

 

Edited by Avishek Dutta

 

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