India’s June core consumer inflation, which strips out the impact of transitory fuel and food prices, was at 3.14% – the lowest since the inception of the gauge in 2012. Core inflation has been declining since the beginning of the year.
“In any economy, when you have sustained declines in core inflation, it not only means that the country has excess capacity, but also that the excess capacity is widening and not narrowing,” Aziz told ET. “So, if you have a country in which the excess capacity is widening, then your interest rates are far too restrictive and, therefore, interest rate needs to be recalibrated lower.”
The Reserve Bank of India (RBI) has kept its benchmark policy rate unchanged at 6.5% over nine straight meetings on concerns over high food inflation. The Monetary Policy Committee is scheduled to meet in early October to review its decision, and its meeting comes within weeks after the US Federal Reserve reduced rates for the first time in more than four years in mid-September.
“The RBI should cut, regardless of what the recorded growth shows, as the proof of the pudding is in the inflation,” Aziz said. “Core inflation today is at its lowest since the inception of the index in 2012. And over the last nine months, core inflation has been falling.”
Multiple Goals
Although the RBI is a single objective – ‘inflation targeting’ – central bank, in practice it balances several objectives, he said. “The RBI may be technically an inflation-targeting central bank, but in practice, it juggles several objectives: FX, growth, inflation, bond yields, and financial stability,” Aziz said. “So, in balancing all these objectives, it uses multiple instruments. And it has been very successful in doing so.” From the policy response standpoint, India stands out because of the balancing of goals
“By contrast, take the Brazil central bank. It has a single objective, namely inflation. It uses a single instrument, the interest rate. So, if inflation goes up, you know exactly what is going to happen to interest rates. The RBI and other Asian central banks don’t do that. They are multiple objectives – multiple instruments central banks,” he said.
So, it is hard to identify what the RBI is targeting by looking at one instrument. However, it has been signalling a less restrictive approach by letting interbank rates decline from the spike in mid-2023, and more recently this April, he said, referring to the liquidity management policy.
However, interest rates could be affected if geopolitics becomes more volatile.
“If geopolitics flares up, that is going to trump what is happening to interest rates,” he said. “But we are focused on the US elections. And to us, US elections pose the risk of a material change in US economic policy depending on the outcome of the election. This can have a dramatic impact on global economics, particularly on the emerging markets, including India.”
Giving his assessment of the lowering of the rates by the Fed, he explained that three months ago, risks to the labour market and inflation were on the upside, and this meant that the Fed needed to keep up its restrictive stance.
“But over the last few months, those risks have moved to being two-sided. If risk has turned two-sided, then it means that the restrictive stance needs to move toward neutral,” Aziz said. “Consequently, this is a recalibration of the Fed’s stance to the change in risks. However, if monetary policy is being eased, then instead of ending the expansion, the expansion will likely get extended.”