As inflation seemed to be coming under control in recent months, expectations about a rate cut grew. Though the RBI changed the stance to ‘neutral’ from the earlier ‘withdrawal of accommodation’ unanimously, it retained the key rate at 6.5%. in its last meeting in October due to high inflation. The inflation further touched a 14-month high at 6.2% for October, led by a spike in vegetable prices. It is above the RBI’s mandate of 4% with a tolerance band of 2 percentage points on either side. Now, many expect the RBI to cut rates in February next year, instead of earlier expectations of a rate cut in December .
Is Delhi getting impatient?
Recent comments by top Central government functionaries on rate cut appear to suggest a stark difference of opinion on interest rates with the Mumbai-headquartered RBI. Many might think a Delhi-versus-Mumbai battle on interest rate is brewing, while others would interpret it as just a diversity of opinion.
Union Finance Minister Nirmala Sitharaman on Monday said that the current bank interest rates are a pain for borrowers and stressed the need for more affordable rates, particularly as businesses seek to expand.
“What is important is when you look at India’s growth requirements, and you can have so many different voices coming out and saying the cost of borrowing is really very stressful, and a time when we want industries to ramp up and move (to) building capacities, bank interest rates will have to be far more affordable,” Sitharaman said. She also called for more discussion on using interest rates to control food prices and sought to comfort the market by stating that the government was taking measures to address food supply issues to prevent price spikes.
The FM’s statement comes days after Union Commerce and Industry Minister Piyush Goyal stated that targeting food prices through interest rates was an “absolutely flawed theory”. “Food inflation has nothing to do with managing inflation” while adding that policymakers and monetary policy authorities should jointly decide whether food inflation needs to be part of headline inflation,” Goyal said.
“I certainly believe they (RBI) should cut interest rates. Growth needs a further impetus,” he said, while pointing out that a similar suggestion was made by the chief economic adviser V Anantha Nageswaran in his Economic Survey earlier in the year.
Soon after Goyal’s comments, RBI governor Shaktikanta Das said at an event that it is targeting a “holistic” view of stability encompassing “price stability, financial stability and sustained growth. In response to Goyal’s comment, Das said, “I reserve my comment.”
Debate over core inflation versus headline inflation
Goyal’s comments sharply contrast the view the RBI has taken that food inflation pressures cannot be ignored. In August, the Governor said that the public, at large, understands inflation more in terms of food inflation than the other components of headline inflation.
In its Economic Survey for September, the Finance Ministry had said that the headline inflation rate, influenced as it is by a few food items, may not be the most accurate gauge of underlying demand. The observation reflected a growing debate whether high food inflation should dictate overall headline inflation. There have been calls for excluding food inflation from headline inflation and considering only core inflation for monetary policy decision. Food items have been a key driver of retail inflation in India in most part of the last two years, even as core inflation has been trending down, especially since FY23.
This year’s Economic Survey had called for a “re-examining” of the existing inflation-targeting framework adopted by the RBI, pitching for the exclusion of food items, prices of which are often driven by supply constraints rather than demand shocks. “Short-run monetary policy tools are meant to counteract price pressures arising out of excess aggregate demand growth. Deploying them to deal with inflation caused by supply constraints may be counterproductive,” the survey said.
At a press briefing, chief economic advisor V Anantha Nageswaran, who authored the Economic Survey, said monetary policy was “not a tool to manage aggregate supply shocks and food shocks are predominantly supply shocks”. He, however, acknowledged differing views on this issue, and also pointed to the ongoing debate, even in the developed world, about the right inflation targeting metric.
The survey argued that when central banks in developing countries target headline inflation, they effectively target food prices, given the high weight of such items in the inflation gauge (food accounts for more than 40% in the CPI). So, any spike in food prices threatens the inflation target, prompting the central bank to appeal to the government to bring down the food rates. “That prevents farmers from benefiting from the rise in terms of trade in their favour,” it added. Hardships caused by higher food prices for poor and low-income consumers can be addressed through direct benefit transfers or coupons for specified purchases valid for appropriate durations, the survey said.
Nageswaran’s ideas triggered a debate. “Globally, every central bank targets the CPI and there is no reason why we should be different. Once we target the CPI, then we need to stick to headline inflation,” Madan Sabnavis, chief economist at Bank of Baroda, had told ET in July. Sabnavis said that in the past when India targeted inflation based on the wholesale price index (WPI) unofficially, “we had situations where the CPI was high and we lowered interest rate saying WPI is low. It is then we moved to the global concept”.
“RBI may well harbour the view that such signals from CEA, coming at a time when the chatter about a rate cut is picking up, make little sense unless the law is changed. And till that happens, neither can RBI deviate from the statute nor risk its reputation by focusing on core inflation while letting the headline inflation harden on the back of higher food prices, Sugata Ghosh wrote in ET in September.
RBI Governor’s stance
India cannot risk another bout of inflation and the best approach currently would be to remain flexible and wait for inflation to durably align with the central bank’s target, opined Reserve Bank Governor Shaktikanta Das while voting for status quo on benchmark rates during the last MPC meeting. “Monetary policy can support sustainable growth only by maintaining price stability,” Das said, as per the minutes of the Monetary Policy Committee (MPC) meeting held last month.
Any move to cut interest rates right now would be hasty and potentially fraught with risk as inflation remains above target and will stay there in the near term, Das said at an event organised by Bloomberg last month. “Inflation is moderating, with certain risks about which we have to be very vigilant.” Das said. “Therefore, a rate cut at this stage will be very premature and can be very, very risky. When your inflation is 5.5% and the next print is also expected to be high, you can’t be cutting rates at that point.” The October inflation print came at 6.2%, a 14-month high. Inflation had risen to a nine-month high of 5.49% in September, driven by a rise in food prices.
Das had said that September inflation would register a large jump and that the October figure would be high too. “But thereafter, going into November and December, we expect inflation to moderate,” Das said.
When can the RBI cut interest rate?
Inflation unexpectedly surging to a 14-month high of 6.2% in October further delays the prospect of monetary easing by the RBI amid the economy showing signs of slowing. “With inflation breaching the 6% mark in October and expected to exceed the MPC’s estimate for Q3FY25 by at least 60-70 bps, a rate cut in the December meet appears ruled out,” said Aditi Nayar, chief economist and head of research and outreach at ICRA.
Rating agency Crisil expects the MPC to only cut rates toward the end of the fiscal year. Ind-Ra and CareEdge see the rate-setting committee maintaining the status quo, as do others. “We are now less hopeful of a February rate cut,” SBI Research said in a note. “We believe the first rate cut is now effectively pushed back beyond February 2025.”
“Inflation is only likely to dip from January onwards, but this will be driven by base effects. We are now less hopeful of a February rate cut. We believe the first rate cut is now effectively pushed back beyond Feb’25,” the SBI report said.